WASHINGTON, D.C. 20549
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FORM 10-K |
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x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE |
SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2007
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For the fiscal year ended December 31, 2010 | |
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o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE |
SECURITIES EXCHANGE ACT OF 1934 | |
For the transition period from ____________ to ____________
Commission file number: 0-26056
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Image Sensing Systems, Inc. |
(Exact name of registrant as specified in its charter) |
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Minnesota |
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(State or other jurisdiction of incorporation or organization) |
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500 Spruce Tree Centre, 1600 University Avenue West, |
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(Address of principal executive offices) |
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(651) 603-7700(Registrant’s telephone number, including area code)
Not applicable.(Former name, former address and former fiscal year, if changed since last report)
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(651) 603-7700 |
(Registrant’s telephone number, including area code) |
Not applicable. |
(Former name, former address and former fiscal year, if changed since last report) |
Securities registered pursuant to Section 12(b) of the Act: |
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Common Stock, $0.01 par value |
| The NASDAQ Capital Market |
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
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Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yeso Noo
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” and “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
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As of June 29, 2007,30, 2010, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $44,097,715$44,962,906 based on the closing sale price as reported on The NASDAQ Capital Market.
The number of shares outstanding of the registrant’s $0.01 par value common stock as of February 28, 20082011 was 3,927,8064,880,619 shares.
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DOCUMENTS INCORPORATED BY REFERENCE
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Proxy Statement for the 2011 Annual Meeting of Shareholders |
| Part III |
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Image Sensing Systems, Inc.2007 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
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Business |
Business
Image Sensing Systems, Inc. (referred to in this report as “we,” “us,” “our” and the “Company”) develops and markets video and radar image processing products for use in traffic, security, police and parking applications such as intersection control, highway, bridge and tunnel traffic management, venue security, entry control, license plate recognition and traffic data collection.
We are thea leading provider of software-based computer enabled detection, or CED, products and solutions for the intelligent transportation systems, or ITS, industry.industry and adjacent security and law enforcement markets. Our family of products, which we market as Autoscope®, RTMS® and RTMS®,CitySync, provides end users with the tools needed to optimize traffic flow, enhance driver safety, regulate air quality and address emerging security/surveillance concerns. Our technology analyzes signals from sophisticated sensors and transmits the information to management systems and controllers or directly to users.
CED is a process in which software rather than humans examines outputs from various types of sophisticated sensors to determine what is happening in a field of view. In the ITS industry, CED is a critical component of managing congestion and traffic flow. In many markets, it is not possible to build roads, bridges and highways quickly enough to accommodate increasing automobile ownership. For example, in 2007 there were approximately 3.0 million vehicles in Moscow, and the number of vehicles is expected to increase by 50% to 4.5 million vehicles by 2012. In China, 7.013.8 million vehicles were introduced in 2006, with this figure increasing by 133%2010, up from the 9.4 million vehicles introduced in 2008. This is expected to 16.3rise to 19.0 million additional vehicles expected in 2014.2011. We believe this growing use of vehicles worldwide will make CED-based ITS solutions increasingly necessary to complement existing and new roadway infrastructure to manage traffic flow and optimize throughput.
We believe our CED solutions are technically superior to those of our competitors because they have a higher level of accuracy, limit the occurrence of false detection, are generally easier to install with lower costs of ownership, work effectively in a multitude of light and weather conditions, and provide end users the ability to manage inputs from a variety of sensors for a number of tasks. It is our view that the technical advantages of our products make our solutions ideallywell suited for use in ITS as well as adjacent security markets. We believe that the market for CED is increasingly favoring converged solutions that include ITS, security/surveillance and environmental management, which we expect to increase demand for CED products such as ours.
We believe the strength of our distribution channels positions us to increase the penetration of our technology-driven solutions in the marketplace. We market our Autoscope products in North America, the Caribbean and Latin America through an exclusive agreement with Econolite Control Products, Inc., or Econolite, which we believe is the leading distributor of ITS intersection control products in North America and the Caribbean. We market our Autoscope products outside of North America, the Caribbean and Latin America and our RTMS and CitySync products through a combination of distribution and direct sales channels, including our wholly-owned subsidiaries in Hong Kong, Poland and the United Kingdom. Our end users primarily include governmental agencies and municipalities, and, as of December 31, 2007,2010, we had sold over 80,000 instances120,000 units in more than 60 countries.
In June 2010, we purchased all of the outstanding equity of CitySync Limited, or CitySync. CitySync was a privately-held, European-based developer and marketer of automatic number plate recognition, or ANPR, products and solutions. In December 2007, we completed theour purchase of certain assets of EIS asset purchase.Electronic Integrated Systems, Inc., or EIS. EIS was a leading provider of radar-based detection solutions. On a pro forma basis for 2007, our revenues, including revenues from the EIS asset purchase, increased approximately 82% compared with our stand-alone revenues for 2006. In addition to the increased scale we gainedgain through the EIS asset purchase,these transactions, the addition of EIS’ RTMS radarand CitySync’s products and operations expands our addressable markets and selling presence, enables us to provide a wider array of CED products to our end usersuser, and supportsupports the introduction of hybrid product offerings to help drive market demand.
Industry Overview
The Intelligent Transportation Systems Market.Market. The market for ITS is large and growing. According to a December 2007September 2010 report by Global Industry Analysts, Inc., total ITS sales in the United States and Europe for 20072009 were approximately $3.4$4.2 billion and $2.8$3.4 billion, respectively, and total global ITS sales were approximately $8.7$10.8 billion. Global Industry Analysts expects total global ITS sales to reach $12.5$18.6 billion by the end of 2010,2015, representing a compound annual growth rate of 11.6%10.0% for the period from 20002007 to 2010.2015.
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ITS encompasses a broad range of information processing and control electronics technologies that, when integrated into roadway infrastructure, help monitor and manage traffic flow, reduce congestion and enhance driver safety. The ITS market has been built around the detection of conditions that impact the proper operation of roadway infrastructure. ITS applications include a wide array of traffic management systems, such as traffic signal control, automatic number plate recognitiontolling and variable messaging signs. ITS technologies include video vehicle detection, automatic number plate recognition, inductive loop detection, sensing technologies (such as radars), floating cellular data, computational technologies and wireless communications.
In traffic management applications, CED products are used for automated vehicle detection and are a primary data source upon which ITS solutions are built. Traditionally, automated vehicle detection is performed using inductive wire loops buried in the pavement. However, in-pavement loop detectors are costly to install, difficult to maintain, expensive to repair and not capable of wide-area vehicle detection without installations of multiple loops.loops nor recognizing license plate numbers.
Above-ground CED solutions for ITS offer several advantages to in-pavement loop detectors. Above-ground CED solutions tend to have lower total cost of ownership than in-pavement loop detectors because above-ground CED solutions are non-destructive to road surfaces, do not require closing roadways to install or repair, and are capable of wide-area vehicle detection with a single device, thus enabling one input device to do the work of many in-pavement loops. Due to their location above ground, CED solutions have no exposure to the wear and tear associated with expanding and contracting pavement and generally less exposure to the vibration and compaction caused by traffic. Furthermore, in the event of malfunction or product failure, above-ground CED solutions can be serviced and repaired without shutting down the roadway. Each of these factors results in greater up-time and increased reliability of above-ground CED solutions compared to in-pavement loop detectors. Above-ground CED solutions also tend to offer a broader set of detection capabilities and a wider field of view than in-pavement loop detectors. For example, unlike in-pavement loops, above-ground CED solutions can detect smoke and debris. In addition, a single unit video- or radar-based CED system can detect and measure a variety of data points,parameters, including vehicle presence, counts, speed, length, time occupancy, headway and flow rate as well as environmental factors and obstructions to the roadway. An equivalent installation using loops would require many installations per lane.
We believe our Autoscope and RTMS products are competitive with and can take market share from in-pavement loop detectors. We believeBased on our determination, the U.S. ITS videoabove ground detection market sales in 20072010 were approximately $110 to $130$160 million and were growing aton average approximately 20%15% per year.year until the recession of 2009. We also have determined that the market in 2009 and 2010 was flat or slightly down from 2008 levels as governments in North America and Europe faced budgetary constraints. We believe that we are the leader in the U.S. videoabove ground detection market in terms of unit sales, and we estimate that U.S. sales of the in-pavement loop detectors our Autoscope and RTMS products can supplant were approximately $500$300 million in 2007.2010.
Our CitySync solutions add further to our offerings in ITS. In many ITS applications, such as tolling or journey time measurement, it is critical to ascertain the identity of the vehicle or to be able to uniquely identify a vehicle at a different time or location. ANPR is among the most widely used methods for these applications.
We believe that several trends are driving the growth in ITS and adjacent market segments:
Proliferation of Traffic.In many countries, there has been a surge in the number of vehicles on roadways. Due to the growth of emerging economies and elevated standards of living, more people desire and are able to afford automobiles. For example, in 2006 thereChina, 13.8 million vehicles were 7.0introduced in 2010, up from the 9.4 million new vehicles introduced in China and the number2008. This is expected to be 7.5rise to 19.0 million in 2007 and 16.3 million by 2014.2011. The number of vehicles utilizing the world’s roadway infrastructure is growing at a quicker pace than new roads, bridges and highways are being constructed. The population of the United States has grown by about 30%, or 70 million, from 1982 to 2007, while highway miles have increased by approximately 5% in the same period. Between 1970 and 2005, the number of registered highway vehicles in the U.S. increased from 111 million to 247 million. Overall, the growth in roadway infrastructure is failing to match the surge in the number of vehicles using it. CED-based traffic management and control systems attempt to solve the problem by monitoring high traffic areas and analyzing data that can be used to mitigate traffic problems.
The Demographics of Urbanization. Accelerated worldwide urbanization drives the creation and expansion of middle classes and produces heightened demand for automobiles. Currently, there are over 400 cities in the world with over 1 million people. Since automobiles can be introduced to a metropolitan area faster than roadway infrastructure can be constructed, the result is continuously worsening traffic. Because expanding the roadway infrastructure is slow and costly to implement, and often environmentally undesirable, government agencies are
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increasingly turning to technology-based congestion solutions that optimize performance and throughput of existing and new roadway infrastructure. Detection is the requisite common denominator for any technology-based solution.
The Melding of Large City Service Domains.Large cities require a wide range of service domains, including traffic, security/surveillance and environmental protection. These cities are increasingly turning to centralized management of these service domains, employing a command and control model that requires sharing and integrating data across service domains to operate effectively.effectively – so called “Smart Cities” initiatives. For example, data collected for the traffic management service domain is relevant to all of the other service domains. This means that each CED sensor can supply information to multiple domain services. In turn, we believe the sharing of detection information across service domains willshould increase the level of sophistication required to process and interpret that information.
Advances in Wireless Technology Create the Ubiquitous Network.Businesses and government entities, motivated by the need for improved productivity and functionality, are increasingly adopting pervasive, networked information systems. The internet and widely available broadband networks, including recent advances in wireless technologies such as mesh networks, have greatly reduced the deployment costs of adding broadly distributed CED solutions to existing information systems. We believe thatThe lower cost of deployment willshould increase demand for CED.
The Ascendancy of CED. Electronics of all sorts are becoming smaller and less costly to manufacture, while becoming more capable of performing certain complicated tasks than humans. CED solutions benefit from these trends. Of particular significance is the evolving concept of hybrid detection in which two or more sensing types such as radar and video are combined in a common CED device in which the weaknesses of each are synergistically offset by the strengths of the other. By leveraging a common digital signal processor and network interface, we believe the incremental cost of a hybrid device will be significantly lower than deploying multiple, single-sensor CED devices. This makes the concepts of “rich sensing” and “instrumenting the city” through CED solutions cost effective, which we believe will result in the extensive proliferation of sophisticated sensors and detection devices.
The non- ITS Automatic Number Plate Recognition Market. In addition to ITS, ANPR is widely used for applications in security, police and parking, among others. We believe the sum of these markets is significant and currently is in excess of $200 million for their ANPR components. We also believe the competitive landscape is fragmented, with no dominant market share for any one competitor.
Security. ANPR is used in security applications world-wide for border-crossings, airports and venues such as convention centers or sports arenas. Additionally, private industry uses ANPR to help control entrances at high value locations, such as power plants. Homeland security and counter-terrorism activities benefit from ANPR as part of the solution.
Police.Law enforcement has adopted ANPR for a variety of applications. Police may use ANPR to gather information on a stopped vehicle in a faster, automated fashion. ANPR can scan for vehicles of interest from a fixed position or from a moving police vehicle, looking for stolen cars or for automobiles of individuals with arrest warrants outstanding. Also, ANPR is regularly used as a component of red light, speed and bus lane enforcement systems.
Parking. Both public and private parking facilities have recently undergone a significant period of automation where human attendants have been replaced by machines that control access. ANPR is employed in numerous parking functions including automatic entrance/exit, open spot locator assistance, lost vehicle location, theft-avoidance and related security aspects.
Solutions for Adjacent Markets.Markets. We believe that the adjacent markets of ITS, security/surveillance and environmental management are converging, and that this convergence will accelerate as CED systems become more cost-effective when a single CED unit can be used for multiple purposes. Because the CED technologies involved are closely related, we believe our CED technology can be adapted to or is already capable of addressing these adjacent markets. According to Civitas Group, the global market for homeland security is estimated in 2006 to have been approximately $55.0 billion; whereas National Defense Magazine states that the environmental management market was $520.0 billion in 2002. Both are growing.
We believe that environmental management systems will become a necessity, especially in large cities where the costs of air pollution are being increasingly borne by city residents. Long traffic delays ensure thatresult in idling vehicles that have adverse effects on urban areas. In conjunction with video detection for ITS, CED products can help governmental agencies reduce air pollution and energy consumption by controlling traffic flow and reducing travel time, accidents and delays. We believe that theThe convergence of traffic, security/surveillance and environmental management should drive significant continued CED demand growth.
Our Competitive Strengths
We are thea leading provider of software-based CED products and solutions for the ITS industry.industry and related security and law enforcement markets. We have the following competitive strengths that we expect will continue to enhance our leadership position in ITS and adjacent industries:position:
Leading Proprietary Technologies.Technologies. Over the last two decades, we have developed or acquired a proprietary portfolio of complex software algorithms and applications that we have continuously enhanced and refined. These algorithms, which include our advanced signal processing technologies, allow our video and radar detection products to capture and analyze objects in diverse weather and lighting conditions and to balance the accuracy of positive detection and the avoidance of false detections. Due to the strength of theseour proprietary technologies, we believe we command premium pricing and, as a result, have achieved, on average, annual double-digit revenue growth over the last five years.pricing. CED technologies similar to ours are also difficult to develop and refine in a
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commercially viable manner. We therefore believe we areshould be well positioned to quickly introduce next-generation products to market and continue our historically strong growth.market.
Proven Ability to Develop, Enhance and Market New Products.Products. We are continually developing and enhancing our product offerings. Over the last two decades, we have demonstrated theour ability to lead the market with new products and product enhancements. For example, we werethe Autoscope Solo system was the first company to provide our end users with a fully integrated color camera, zoom lens and machine vision processor in our Autoscope Solo system. Additionally,the above ground detection market. EIS was one of the first companies to introduce radar-based technology solutions for ITS applications, and it has continued to lead the market with technology enhancements and new products, such as RTMS.
Additionally, the CitySync system was the first in the ANPR market to capture multiple license plates in the same lane with a standard configuration. We have successfully collaborated with our long-term channel partners to market these new products. We believe that developing, enhancing and marketing new products with our partners translates into strong organic revenue growth and high levels of profitability.
Leading Distribution Channel.Channel. We have maintained a relationship with Econolite for the distribution of our Autoscope products in North America and the Caribbean since 1991 and in Latin America since 2002. We believe that Econolite is the leading distributor of ITS control products in North America and the Caribbean. In our view, this relationship enhances our ability to commercialize and market new products and allows us to focus more resources on our core business ofdeveloping advanced signal processing software algorithms. Although we expect our percentage of revenue attributable to Econolite to somewhat lessen over the next few years due to international diversification, we expect that our revenue dollars attributable to Econolite will continue to grow.
Broad Product Portfolio.Portfolio. Our product portfolio leverages our core software-based algorithms for CED to enable end users to detect and monitor objects in a designated field of view. We believe that our family of Autoscope, RTMS and RTMSCitySync products allows us to offer a broad product portfolio that meets the needs of our end users. Additionally, our intention is to use our broad product portfolio to offer hybrid products that satisfy traffic, security/surveillance and environmental management requirements.
Experienced Management Team and Engineering Staff. We recently transitioned to a new management team charged with executing our growth strategy. Our management team isand engineering staff are highly experienced in the ITS and software industries. Additionally, we believe that the continuity of our engineering staff allowsshould allow us to continuously develop new or improved products.
Strong Financial Performance. Over Prior to the past five years,recession in 2009, we havehad profitably grown our revenue organically at an average double-digit compound annual growth rate. During this time, we maintained average net margins approaching 25%.rate over the six year period from 2003 through 2008. As of December 31, 2007,2010, we had $23.2$46.0 million in shareholders’ equity. OurWe believe our financial performance and strength gives us the ability to take advantage of favorable market trends without the restrictions that often handicap other nimble, leading-edge technology companies similar to us in size.
Our Growth Strategy
As part of our growth strategy, we seek to:
Enhance and Extend Our Technology Leadership in ITS. We believe we have established ourselves as thea leading provider of CED in the ITS market segment. We believe that we nowcontinue to have an opportunity to accelerate our growth while maintaining our traditionally high level of profitability.growth. We believe we willplan to do this by improving the accuracy and functionality of our products and opportunistically expanding our product offering into adjacent markets, as well as expanding our portfolio and channels through licensing or selected acquisitions.licensing. We intend to develop and introduce hybrid CED products which we believe willto take advantage of our technical leadership in ITS and further differentiate us from our competitors.
Expand Success in ANPR Markets.Prior to our acquisition of CitySync in June 2010, it had an annual revenue run rate in excess of $7.0 million and had 10 years of experience in ANPR. We believe that the ANPR market is poised for growth at a higher rate than the ITS market. Further, we believe that our financial strength, distribution channels and customer base will add to our ability to grow CitySync related revenue. We believe these synergies could lead to above average revenue growth.
Expand into Adjacent Markets. Our core skill is the implementation of software-based CED products and solutions. Over the past two decades, we have been developing and refining our complex signal processing software algorithms. We believe thatshould be able to effectively utilize our core software skills can be effectively utilized more broadly as markets, including security/surveillance and environmental management systems, converge. We believe that a driver of this convergence is that CED systems will become more cost-effective when a single CED unit can be used for multiple purposes. As a result, our objective is to become the leading supplier of critical CED components to third party
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management systems, particularly those that exploit the convergence of traffic, security/surveillance and environmental management systems. To do this, we are integrating this concept into our long-range engineering development road-map and will evaluate the use of technology licensing acquisition and channel strategies that support this vision.
Increase the Scope of Our Distribution and Direct Sales.Sales. We have made substantial investments in product adjustments to tailor our solutions to the differing needs of our international end users.users and in new product acquisitions for both domestic and international markets. We have also invested in thesales and marketing expansion, ofwith a focus on our European and Asian subsidiaries. We believe that marketsThe addition of CitySync brought further critical mass to our European organization. Markets in Eastern Europe, the Asia/Pacific region, the Middle East, Africa and South America, which have historically lagged North America and Western Europe in their use of CED, have recently begun to increase the adoption of CED in their traffic, security/surveillance and environmental management systems. We intend to continue to refine our product offerings through engineering development and technology licensing and/or acquisitions to take advantage of the accelerated pace of the adoption of CED throughout the developing world.
Grow Through Complementary Acquisitions. We intend to pursue strategic acquisitions that extend our technology leadership, breadthTable of product offerings and market share in ITS and adjacent market segments. We expect to target acquisitions that will serve as a platform for additional growth opportunities, including new product offerings, technology enhancements and the introduction of new sales and distribution channels. We intend to employ a selective and disciplined approach when evaluating acquisition opportunities.Contents
Our Products and Solutions
Our vehicle and traffic detection products are critical components of many ITS applications, including intersection control, highway management and tunnel safety.adjacent security and law enforcement applications. Our Autoscope video systems and RTMS radar systems convert sensory input collected by video cameras and radar units into vehicle detection and traffic data used to operate, monitor and improve the efficiency of roadway infrastructure. Our CitySync systems use video sensors in the visible and infrared spectrums to read license or number plates for tolling, traffic data, security, police and parking applications. At the core of each product line are proprietary digital signal processing algorithms and sophisticated embedded software that analyze sensory input and deliver actionable data to integrated ITS applications. Between ISS and EIS, we spentWe invested approximately $2.8$3.6 million, $3.3 million and $2.1$2.9 million on research and development in 2007, 20062010, 2009 and 2005,2008, respectively, to develop and enhance our Autoscope and RTMSproduct technology. We believe ourOur digital signal processing software algorithms represent a foundation on which support for additional sensory inputs such as audio,acoustic, chemical, smoke, weather and vibration sensors may be added in the future. A diagram displaying our fundamental product architecture is shown below.
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The Image Sensing Product Architecture
Autoscope. Our Autoscope system processes video input from a traffic scene in real time and extracts the required traffic data, including vehicle presence, counts, speed, length, time occupancy (percent of time the detection zone is occupied), average headway (time interval between vehicles) and flow rate (vehicles per hour per lane). Autoscope supports a variety of standard video cameras or can be purchased with an integrated video camera. For intersections, the system communicates with the intersection signal controller, which changes the traffic lights based on the data provided. In highway applications, the system gathers vehicle count and flow rates and detects anomalous incidents, such as stopped or wrong-way vehicles. In tunnel safety applications, Autoscope provides alerts to operators upon detecting stopped, wrong-way or slow moving vehicles and upon detecting pedestrians, debris or smoke. In any application, the data may also be transmitted to a traffic management center via the internet or other standard communication means and processed in real time to assist in traffic management and stored for later analysis for traffic planning purposes.
All systems come with the latest Autoscope software suite, which provides a communications server and applications software for configuring, monitoring and maintaining system installations. Using a computer mouse, desired detection zones within a camera’s field of view are programmed to specify where and what type of traffic data is collected. The application’s software graphical user interface is currently available in 15 languages. A translation kit is available to translate the graphical user interface into other local languages as may be necessary or desired.
The Autoscope system runs on our Terra platform, which we introduced in April 2007. Enhancements to the Terra platform include the use of the Texas Instruments DaVinci dual core advanced RISCTM machine and digital signal processor, digital MPEG-4 video streaming, high speed Ethernet interface, web browser maintenance and data and video over power line communications.
The Terra platform comes in the following two varieties:
Autoscope Solo Terra. Thevarieties. Autoscope Solo Terra is anour integrated color zoom camera and machine vision processing computer contained in one compact housing unit that is situated on roadway infrastructure overlooking the traffic scene. The Solo Terra provides the best performance of our platforms due to the high-quality video
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resulting from the integration of camera and processor. The Solo Terra is our leading Autoscope offering in the North American market.
Autoscope RackVision Terra. The Autoscope RackVision Terra allows end users to use standard video cameras (both new or previously installed) with Autoscope technology. The RackVision Terra consists of ais our card only machine vision processing computer that is located in an intersection signal controller, control hub, incident management center or traffic management center that receives video from a separate camera. The RackVision Terra isand its variants are our top selling Autoscope productproducts in international markets.
Sales of and royalties from the Autoscope system have generated substantially all of our revenues since our inception.
RTMS. Our RTMS systems use radar to measure vehicle presence, volume, occupancy, speed and classification information for roadway monitoring applications. Data is transmitted to a central computer at a traffic management center via the internet or other standard communication means, including wireless. Data can be processed in real-timereal time to assist in traffic management and stored for later analysis for traffic planning purposes.
RTMS is an integrated radar transmitter/receiver and special purpose computer contained in a compact, self-contained unit. The unit is typically situated on roadway poles and side-fired, making it especially well suited for highway detection applications.
CitySync. Our CitySync systems process video information gathered from the visible and infrared spectrum to perform ANPR for ITS, security, police and parking applications. Data is transmitted to other integrated systems or stored in onboard vehicle systems for later processing. Data can be processed to assist in traffic and parking management, tolling applications, real-time law enforcement and traffic alerts and stored for later analysis for traffic, security and commercial purposes.
At the core of each CitySync system is the JetBase software suite which runs the ANPR algorithms and related processes including communications. JetBase operates with both non-proprietary and proprietary cameras. We offer a range of proprietary analog, high definition and intelligent cameras for both fixed and mobile systems.
Comparison of Video and Radar Detection.Detection Types.Video detection is best suited to applications in which the ability to act on complex and detailed information is desired. However, video can encounter difficulties in poorly-lit environments, in adverse weather conditions (such as fog or driving snow), in situations in which vehicles are obscured (for example, by other vehicles), or in extraordinarily dirty environments in which airborne particulates obscure the view. Also, despite the compensating factors of using high-quality color video, video can be susceptible to false detections due to shadows or reflections. Radar is less able to distinguish fine details than video but is considerably less affected by adverse environmental conditions and to some degree can see through certain kinds of obstructions. It also does not recognize shadows or visual reflections.
We believe that byBy combining video and radar sensors and algorithmically comparing their outputs, we believe we will be able to offer our end users products that provide superior accuracy. Hybrid CED detectors should be able to coalesce the strengths of each type of sensor to overcome the other’s limitations. The result iswill be improved overall performance in a broader range of circumstances.
Distribution, Sales and Marketing
We market and sell our products globally. As of December 31, 2007,2010, we had supplied systems for more than 80,000 instances120,000 units in more than 60 countries. Together with our partners, we offer a combination of high-performance CED technology and experienced local support. Our end users primarily consist of federal, state, city and county departments of transportation, road commissions and port, highway, tunnel, toll and other transportation authorities.authorities, law enforcement agencies and parking facility operators. The decision-makers within these governmental entities typically are traffic planners and government engineers, who in turn often rely on consulting firms that perform planning and feasibility studies for the governmental entities.studies. Our products sometimes are sold directly to system integrators or other suppliers of systems and services who are operating under subcontracts in connection with major road construction contracts.
Autoscope North American, Caribbean and Latin American Sales.We have granted Econolite an exclusive right to manufacture, market and distribute the Autoscope system in North America, the Caribbean and Latin America. The agreement with Econolite grants it a first refusal right that arises when we make a proposal to Econolite to extend the license to additional products in North America, the Caribbean and Latin America and a first negotiation right that arises when we make a proposal to Econolite to include rights corresponding to Econolite’s rights under our current agreement in countries not in these territories. Econolite provides the marketing and technical support needed for its sales in these territories. Econolite pays us a royalty on the revenue derived from its sales of the Autoscope system. We cooperate in marketing Autoscope products with Econolite for North America, the Caribbean and Latin America and provide second-tier technical support. We have the right to terminate our agreement with Econolite if it does not meet minimum annual sales levels or if Econolite fails to make payments as
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required by the agreement. The initialIn 2008, the term of the agreement was 15 years, ending in 2006. In 2001, we signed a five-year extension of our agreement with Econolite, extending its original termextended to June 2011.2028. The agreement is automatically renewable for additional one-year periods unlesscan be terminated by either party upon 60 days’three years’ notice.
RTMS and CitySync North American, Caribbean and Latin American Sales.We market the RTMS systemand CitySync systems to a network of distributors covering countries in North America, the Caribbean and Latin America. On a limited basis, we sell directly to the end-user. We provide technical support to these distributors from our office in Toronto.various North American locations.
European and Asian Sales.We market Autoscope, RTMS and RTMSCitySync to a network of distributors covering countries in Europe, the Middle East, Africa and Asia through our wholly-owned subsidiaries that have offices in Hong Kong, Poland and the United Kingdom. On a limited a basis, we sell directly to the end-user. Technical support to these distributors is provided by our wholly-owned subsidiaries in Europe and Asia, with second-tier support provided by our Toronto office or our corporate headquarters in St. Paul, Minnesota.engineering groups.
Competition
We compete with companies that develop, manufacture and sell traffic management devices using machine visionvideo and radar sensing technologies as well as other above-ground CED technologies based on laser, infrared and acoustic sensors. WeFor ITS applications, we also compete with providers of in-pavement loop detectors and estimate that more than 80% of the traffic management systems currently in use in the U.S. use in-pavement loop detectors. For competition with other above-ground CED products, we typically compete on performance and functionality, and to a lesser extent on price. When competing against providers of loop detectors, we compete principally on ease of installation and the total cost of ownership over a multi-year period, and to a lesser extent on functionality.
Among the companies that provide direct competition to the Autoscope system worldwide are Traficon N.V., Quixote Corporation,Signal Group Inc. (Semex), Iteris, Inc. and Citilog S.A. Among the companies that provide direct competition to RTMS worldwide are Wavetronix, LLC, MS Sedco Inc. and Xtralis, LLC. Among the companies that provide direct competition to CitySync worldwide are Federal Signal Corporation (PIPS), Perceptics LLC, Genetec Inc., Elsag Datamat S.p.a. All of these companies have working installations of their machine visionvideo or radar systems in the U.S. and other parts of the world. To our knowledge, however, these companies do notAutoscope and RTMS have as manythe largest number of installations as we have.compared to their direct competitors. In addition, there are smaller local companies providing direct competition in specific markets such as Korea, China and Japan.throughout the world. We are aware that these and other companies will continue to develop technologies for use in traffic management, security, police and surveillance.parking applications. One or more of these technologies could in the future provide increased competition for our Autoscope and RTMS systems.
Other potential competitors of which we are aware include Siemens AG, Cognex Corp., Matsushita Electric Industrial Co., Ltd. (Panasonic), Sumitomo Corporation, Omron Electronics LLC and 3M Company. These companies have machine vision or radar capabilities and have substantially more financial, technological, marketing, personnel and research and development resources than we have.
Manufacturing
We currently have the Autoscope family of products for sale in North America,under the Caribbean and Latin AmericaEconolite license agreement are manufactured through agreements with Econolite and Wireless Technology, Inc., or WTI. In 1991, we appointed Econolite as our exclusive licensee to manufacture and sell the Autoscope system and related technology and to sell the products in North America and the Caribbean. In 2002, we granted Econolite an exclusive license to sell Autoscope products in Latin America,is responsible for setting warranty terms and we granted WTI a non-transferable license to use any of our intellectual property as needed to manufacture Autoscope products for our use and Econolite’s use.must provide all service required under this warranty. In Europe and Asia, we engage contract manufacturers to manufacture the Autoscope family of products. Econolite provides a one-year warranty on the Autoscope system and must provide all service required under this warranty. WTI provides Econolite a limited two-year warranty on material and workmanship on the products it manufactures. The terms of the warranties vary for overseas manufacturers.
For RTMS products, we engage contract manufacturers to produce subassemblies based on our designs. These subassemblies are then shipped to our facilities in Toronto, where we perform final assembly, testing and calibration and packaging of finished units for shipment. For most RTMS products, we provide a two-year warranty. We also perform warranty and post-warranty repairs of RTMS units in Toronto.
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Table of Contents We typically provide a two-year warranty on our products.
Most of the hardware components used to manufacture our products are standard electronics components that are available from multiple sources. Although some of the components used in our products are obtained from single-source suppliers, we believe other component vendors are available should the necessity arise. To our knowledge, our contract manufacturing and component vendors in Europe and Asia comply with the European directive on RoHS, which is the restriction of the use of certain hazardous substances in electrical and electronic equipment.
Intellectual Property
To protect our rights to our proprietary know-how, technology and other intellectual property, it is our policy to require all employees and consultants to sign confidentiality agreements that prohibit the disclosure of confidential information to any third parties. These agreements also require disclosure and assignment to us of any discoveries and inventions made by employees and consultants while they are devoted to our business activities. In addition, in the EIS asset purchase, we acquired six patent applications on file with the U.S. Patent and Trademark Office relating to the RTMS products and technology. We also rely on trade secret, copyright and trademark laws to protect our intellectual property.
We intend to protect our intellectual property assets and will actively seek, when appropriate, protection for owned or licensed products and proprietary information by means of U.S. and foreigninternational copyrights, trademarks, patents and contractual arrangements. We have registered trademark rights to “Autoscope” and “Autoscope Solo”“RTMS” in 29 countries, including the U.S. and mostin the European Union (E.U.). We have further registered “Autoscope” in Canada and 10 Asian-Pacific Rim countries, including China, while “RTMS” is pending registration in several additional countries. “CitySync” and we also have“Jet” trademark designs are registered RTMS in the U.S.
and E.U. We entered into a license agreement with the University of Minnesota in 1991. Under the agreement, the University granted us the exclusive righthave other product trademarks that we have chosen not to make, have made,register, but we aggressively monitor and protect their use sell and lease any product that incorporated knowledge, information, know-how, software and devices in the possession ofmarket. Our patent portfolio includes six patents on RTMS technology which are registered in the University, including aU.S. and select E.U. countries, one CitySync ANPR patent held byregistered in the University, related to a video vehicle detection system developed byU.K. and two CitySync patent applications pending in the University, including improvements toU.S. and the technology. The patent expired in July 2006. The expiration of the University patent in July 2006 made the technology covered by the patent available to the public, allowing others to use the technology to design, manufacture and sell a product which could compete with our Autoscope product. However, since 1991, we have extensively added to the technology and product design to include our own intellectual property, and we have made extensive moderations and revisions to the University technology. We also developed our own techniques to made the technology commercially feasible. Consequently, we believe that the expiration of the University patent is not a threat to our business.E.U.
Employees
As of February 1, 2008,28, 2011, we had 80 employees. Of these, 21123 employees, were employed by our overseas subsidiariesconsisting of 73 employees in Hong Kong, the United KingdomNorth America, 36 employees in Europe and Poland.14 employees in Asia. None of our employees is represented by a union. We believe our employee relations are good.
Cautionary StatementTable of Contents
Risk Factors |
Information Regarding Forward-Looking Statements
This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange of 1934, as amended. Forward-looking statements represent our expectations or beliefs concerning future events and can be identified by the use of forward-looking words such as “believes,” “may,” “will,” “should,” “intends,” “plans,” “estimates,” or “anticipates” or other comparable terminology. Forward-looking statements are subject to risks and uncertainties that may cause our actual results to differ materially from the results discussed in the forward-looking statements. Some factors that might cause these differences include the factors listed below. Although we have attempted to list these factors comprehensively, we wish to caution investors that other factors may prove to be important in the future and may affect our operating results. New factors may emerge from time to time, and it is not possible to predict all of these factors, nor can we assess the affect each factor or combination of factors may have on our business.
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We further caution you not to unduly rely on any forward-looking statements, because they reflect our views only as of the date the statements were made. We undertake no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise.
Historically, substantially all of our revenue has been generated from sales of our Autoscope family of products, and if we do not maintain the market for these products, our business will be harmed.
Historically, substantially all of our revenue has been generated from sales of, or royalties from the sales of, the Autoscope Vehicle Detection System. We anticipate that revenue from the sale of the Autoscope system will continue to account for a substantial portion of our revenue for the foreseeable future. As such, any decline in sales of our Autoscope system would have a material adverse impact on our business, financial condition and results of operations.
The features and functions in our products have not been as widely utilized as traditional products offered by our competitors, and the failure of our end users to provide greater demand for the features and functions in our products could adversely affect our business and growth prospects.
Machine vision and radar technologies have not been utilized in the traffic management industry as extensively as other more traditional technologies, mainly in-pavement loop detectors. Our financial success and growth prospects depend on the continued development of the market for advanced technology solutions for traffic management and the acceptance of our Autoscope and RTMS systems, and future systems we may develop, as reliable, cost-effective alternatives to traditional vehicle detection systems. We cannot assure you that we will be able to utilize our technology profitably in other products or markets. If our end users do not continue to increase their demand for the features and functions provided by our Autoscope and RTMS systems, or hybrid or other systems we may develop, our business and growth prospects could be adversely affected.
If governmental entities elect not to use our products due to budgetary constraints, project delays or other reasons, our revenue may fluctuate severely or be substantially diminished.
The Autoscope and RTMS systemsOur products are sold primarily to governmental entities for use in large traffic control projects using advanced technologies.entities. We expect that we will continue to rely substantially on revenue and royalties from sales of the Autoscope and RTMSour systems to governmental entities. In addition to normal business risks, it often takes considerable time before governmental traffic controlinitiated projects are developed to the point at which a purchase of the Autoscope and RTMSour systems would be made, and a purchase of our products also may be subject to a time-consuming approval process. Additionally, governmental budgets and plans may change without warning. Other risks of selling to governmental entities include dependence on appropriations and administrative allocation of funds, changes in governmental procurement legislation and regulations and other policies that may reflect political developments, significant changes in contract scheduling, competitive bidding and qualification requirements, performance bond requirements, intense competition for government business and termination of purchase decisions for the convenience of the governmental entity. Substantial delays in purchase decisions by governmental entities, or governmental budgetary constraints, could cause our revenue and income to drop substantially or to fluctuate significantly between fiscal periods.
A majority of our gross profit has been generated from sales of our Autoscope family of products, and if we do not maintain the market for these products, our business will be harmed.
Historically, a majority of our gross profit has been generated from sales of, or royalties from the sales of, Autoscope products. Gross profit from Autoscope sales accounted for approximately 63% of our gross profit in 2010, 73% in 2009 and 76% in 2008. We anticipate that gross profit from the sale of Autoscope systems will continue to account for a substantial portion of our gross profit for the foreseeable future. As such, any significant decline in sales of our Autoscope system would have a material adverse impact on our business, financial condition and results of operations.
If Econolite’s sales volume decreases or if it fails to pay royalties to us in a timely manner or at all, our financial results will suffer.
We have an agreement with Econolite under which Econolite is the exclusive distributor of the Autoscope system in North America, the Caribbean and Latin America. The agreement also grants Econolite a first refusal right that arises when we make a proposal to Econolite to extend the license to additional products in North America, the Caribbean and Latin America andAmerica. In addition, the agreement grants Econolite a first negotiation right that arises when we make a proposal to Econolite to include rights corresponding to Econolite’s rights under our current agreement in countries not in these territories. In exchange for its rights under the agreement, Econolite pays us royalties for sales of the Autoscope system. Since 2002, more than 70%a substantial portion of our revenue has consisted of royalties resulting from sales made by Econolite, including 71%40% in 2007, 77%2010, 49% in 20062009 and 78%50% in 2005.2008. Econolite’s account receivable represented 71%25% of our accounts receivable at December 31, 20072010 and 69%39% of our accounts receivable at December 31, 2006.2009. We
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expect that Econolite will continue to account for a significant portion of our revenue for the foreseeable future. Any decrease in Econolite’s sales volume could significantly reduce our royalty revenue and adversely impact earnings. A failure by Econolite to make royalty payments to us in a timely manner or at all will harm our financial condition. In addition, we believe sales of our products are a material part of Econolite’s business, and any significant decrease in Econolite’s sales of the other products it sells could harm Econolite, which could have a material adverse effect on our business and prospects.
Increased competition may make it difficult for us to acquire and retain end users. If we are unsuccessful in developing new applications and product enhancements, our products may become noncompetitive or obsolete.
Competition in the area of advanced traffic management and surveillance is growing. Some of the companies that may compete with us in the business of developing and implementing traffic control systems have substantially more financial, technological, marketing, personnel and research and development resources than we have. Therefore, they may be able to respond more quickly than we can to new or changing opportunities, technologies, standards or end user requirements. If we are unable to compete successfully with these companies, the market share for our products will decrease, and competitive pressures may seriously harm our business.
Additionally, the market for vehicle detection is continuously seeking more advanced technological solutions to traffic management and control problems. Technologies such as embedded loop detectors, pressure plates, pneumatic tubes, radars, lasers, magnetometers, acoustics and microwaves that have been used as traffic sensing devices in the past will be enhanced for use in the traffic management industry, and new technologies may be developed. We are aware of several companies that are developing traffic management devices using machine vision technology or other advanced technology. We expect to face increasingly competitive product developments, applications and enhancements. New technologies or applications in traffic control systems may provide our end users with alternatives to the Autoscope and RTMS systems and could render our solutions noncompetitive or obsolete. If we are unable to increase the number of our applications and develop and commercialize product enhancements and applications in a timely manner that responds to changing technology and satisfies the needs of our end users, our business and financial results will suffer.
Our dependence on third parties for manufacturing and marketing our products may prevent us from meeting customers’ needs in a timely manner.
We do not have, and do not intend to develop in the near future, internal capabilities to manufacture our products. We have entered into agreements with Econolite and Wireless Technology, Inc., or WTI, to manufacture the Autoscope system and related products for sales in North America, the Caribbean and Latin America. The hardware components for our RTMS products are made by manufacturers in Taiwan and Canada, and the components are assembled and tested in Canada. In addition, we work with suppliers, some of whom are overseas, to manufacture Autoscope and RTMS products that need to comply with the European Union’s regulatory RoHS directive on the restriction of the use of certain hazardous substances in electrical and electronic equipment. If Econolite, WTI and our suppliers are unable to manufacture our products in the future, we may be unable to identify other manufacturers able to meet product and quality demands in a timely manner or at all. Our inability to find suitable manufacturers for our products could result in delays or reductions in product shipments, which in turn may harm our business reputation and results of operations. In addition, we have granted Econolite the exclusive right to market the Autoscope system and related products in North America, the Caribbean and Latin America. Consequently, our revenue depends to a significant extent on Econolite’s marketing efforts. Econolite’s inability to effectively market the Autoscope system, or the disruption or termination of that relationship, could result in reduced revenue and market share for our products.
We and our third party manufacturers obtain some of the components of our products from a single source, and an interruption in the supply of those components may prevent us from meeting customers’ needs in a timely manner and could therefore reduce our sales.
Although substantially all of the hardware components incorporated into the Autoscope and RTMS systems are standard electronics components that are available from multiple sources, we and our third party manufacturers obtain some of the components from a single source. The loss or interruption of any of these supply sources could
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force us orThe features and functions in our manufacturers to identify new suppliers, which could increaseproducts have not been as widely utilized as traditional products offered by our costs, reduce our salescompetitors, and profitability, or harm our customer relations by delaying product deliveries.
We may face increased competition if we fail to adequately protect our intellectual property rights, and efforts to protect our intellectual property rights may result in costly litigation.
Our success depends in large measure on the protectionfailure of our proprietary technology rights. We rely on trade secret, copyrightend users to accept the features and trademark laws, and confidentiality agreements with employees and third parties, all of which offer only limited protection. Although we acquired six patent applications filed with the U.S. Patent and Trademark Office, or USPTO,functions in the EIS asset purchase, we cannot assure you that the scope of these or any future patents relating to our products will exclude competitors or provide competitive advantages to us. We also cannot assure you that we will become aware of all instances in which others develop similar products, duplicate any of our products, reverse engineer or misappropriate our proprietary technology. If our proprietary technology is misappropriated, our business and financial results could be adversely affected. Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. In addition, we may be the subject of lawsuits by others who claim we violate their intellectual property rights. Even if the result is favorable, litigation could result in substantial costs and the diversion of management resources, either of which could harm our business.
As described above, although we have acquired six patent applications filed with the USPTO, we have not applied for patent protection in all countries in which we market and sell the Autoscope and RTMS systems. Consequently, our proprietary rights in the technology underlying the Autoscope and RTMS systems in countries other than the U.S. will be protected only to the extent that trade secret, copyright or other non-patent protection is available and to the extent we are able to enforce our rights. The laws of other countries in which we market our products may afford little or no effective protection of our proprietary technology, which could harm our business.
The expiration of the University of Minnesota patent for certain aspects of our Autoscope system may result in additional competition, which could adversely affect our revenue and earnings.
The patent rights for certain aspects of the underlying technology for the Autoscope system previously owned by the University of Minnesota expired in July 2006. Other businesses may choose to use the University patent technology to develop a product that competes with the Autoscope system, and this competition could adversely impact our revenue and earnings.
We plan to continue introducing new products and technologies and may not realize the degree or timing of benefits we initially anticipated, which could adversely affect our business and results of operations.growth prospects.
We regularly invest substantial amountsVideo and radar technologies have not been utilized in researchthe traffic management industry as extensively as other more traditional technologies, mainly in-pavement loop detectors. Our financial success and development efforts that pursue advancements in a range of technologies, products and services. Our ability to realizegrowth prospects depend on the anticipated benefits of these advancements depends on a variety of factors, including meetingcontinued development production, certification and regulatory approval schedules; execution of internal and external performance plans; availability of supplier-produced parts and materials; performance of suppliers and vendors; achieving cost efficiencies; validation of innovative technologies; and the level of end user interest in new technologies and products. These factors involve significant risks and uncertainties. We may encounter difficulties in developing and producing these new products and may not realize the degree or timing of benefits initially anticipated. In particular, we cannot predict with certainty whether, when or in what quantities our current or potential end users will have a demand for products currently in development or pending release. Moreover, as new products are announced, sales of current products may decrease as end users delay making purchases until such new products are available. Any of the foregoing could adversely affect our business and results of operations.
We price our products at a premium compared to other technologies. As such, we may not be able to quickly respond to emerging low-cost competitors, and our inability to do so could adversely affect revenue and profitability.
We price our products at a premium as compared to less sophisticated technologies. As the technological sophistication of our competitors and the size of the market increases, competing low-cost developers of machine vision
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productsfor advanced technology solutions for traffic are likely to emergedetection and grow stronger. If end users prefer low-cost alternatives over our products, our revenuemanagement and profitability could be adversely affected.
Our revenue could be adversely affected by the emergenceacceptance of local competitors and local biases in international markets.
Our experience indicates that local officials that purchase traffic management products in the international markets we serve favor products that are developed and manufactured locally. As local competitors to our products emerge, local biases could erode our revenue in Europe and Asia and adversely affect our sales and revenue in those markets.
Failure to predict technological convergence could harm our business and could reduce our sales.
With our Autoscope and RTMS product families, we currently utilize only certain detection technologies available in the ITS field. If we fail to predict convergence of technology preferences in the market for ITS, or fail to acquire complementary businesses or products that broaden our current product offerings,Autoscope, RTMS and CitySync systems and also future systems we may faildevelop as reliable, cost-effective alternatives to capture certain segments of the market, which could harm our business and reduce our sales.
traditional vehicle detection systems. We sell our products internationally and are subject to various risks relating to such international activities, which could harm our international sales and profitability.
During 2007, 2006 and 2005, 27%, 23% and 22% of our total revenue, respectively, was attributable to international sales. We sell outside of the U.S. through our agreement with Econolite, through our wholly-owned subsidiaries and through our distributor network. By doing business in international markets, including Canada, we are exposed to risks separate and distinct from those we face in our domestic operations. Our international business may be adversely affected by changing economic conditions in foreign countries. Because most of our sales are currently denominated in U.S. dollars, if the value of the U.S. dollar increases relative to foreign currencies, our products could become more costly to the international consumer and therefore less competitive in international markets, which could adversely affect our profitability. Furthermore, although currently only a small percentage of our sales are denominated in non-U.S. currency, this percentage may increase in the future, in which case fluctuations in exchange rates could affect demand for our products. Engaging in international business inherently involves a number of other difficulties and risks, including:
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Our exposure to each of these risks may increase our costs, lengthen our sales cycle and require significant management attention. We cannot assure you that one or more of these factors will not harm our business.
Our inability to comply with European and Asian regulatory restrictions over hazardous substances and electronic waste could restrict product sales in those markets and reduce profitability in the future.
The European Union has finalized the Waste Electrical and Electronic Equipment, or WEEE, directive, which makes producers of electrical goods financially responsible for specified collection, recycling, treatment and disposal of past and future covered products. This directive must now be enacted and implemented by individual
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European Union governments, and certain producers are to be financially responsible under the WEEE legislation. This may impose on us requirements, which, if we are unable to meet them, could adversely affect our ability to market our products in European Union countries, and sales revenues and profitability would suffer as a consequence. In addition, the European Parliament has enacted a directive for the restriction of the use of certain hazardous substances in electrical and electronic equipment, or RoHS. This legislation governs restriction of the use of such substances as mercury, lead, cadmium and hexavalent cadmium. If we are unable to have our product manufactured in compliance with the RoHS directive, we would be unable to market our products in European Union countries, and sales revenues and profitability would suffer. In addition, various Asian governments could adopt their own versions of environment-friendly electronic regulations similar to the European directives, RoHS and WEEE. This could require new and unanticipated manufacturing changes, product testing and certification requirements, thereby increasing cost, delaying sales and lowering revenue and profitability.
Our inability to manage growth effectively could seriously harm our business.
Growth and expansion of our business could significantly strain our capital resources as well as the time and abilities of our management personnel. Our ability to manage growth effectively will require continued improvement of our operational, financial and management systems and the successful training, motivation and management of our employees. If we are unable to manage growth successfully, our business and operating results will suffer.
Our business operations will be severely disrupted if we lose key personnel or if we fail to attract and retain qualified personnel.
Our technology depends upon the knowledge, experience and skills of our key management and scientific and technical personnel. Additionally, our ability to continue technological developments and to market our products, and thereby develop a competitive edge in the marketplace, depends in large part on our ability to attract and retain qualified scientific and technical personnel. Competition for qualified personnel is intense, and we cannot assure you that we will be able to attractutilize our technology profitably in other products or markets. If our end users do not continue to increase their acceptance of the features and retainfunctions provided by our current systems or hybrid or other systems we may develop in the individuals we need, especially iffuture, our business expands and requires us to employ additional personnel.growth prospects could be adversely affected.
Existing and future laws, regulations and constitutional provisions protecting privacy rights could delay the acceptance and sale of our video and ANPR products and systems and have a negative effect on our financial condition and results of operations.
The use of video and ANPR products and systems has been challenged and limited under existing laws, regulations and constitutional provisions protecting privacy rights. For example, both Maine and New Hampshire have laws limiting the use of ANPR systems. In addition, laws, regulations and constitutional provisions may be adopted in the lossfuture to limit the use of personnel orvideo and ANPR products and systems. These existing and new laws, regulations and constitutional provisions could negatively affect the acceptance and sale of our failure to hire additional personnel could materiallyvideo and adversely affectANPR products and systems and thus have a negative effect on our business, operatingfinancial condition and results and ability to expand. The loss of key personnel, including Ken Aubrey and Dan Manor, or our inability to hire and retain qualified personnel, will harm our business.operations.
Our operating costs tend to be fixed, while our revenue tends to be seasonal, thereby resulting in operating results that fluctuate from quarter to quarter.
Our expense levels are based in part on our product development efforts and our expectations regarding future revenues and, in the short-term, are generally fixed. Our quarterly revenues, however, have varied significantly in the past, with our first quarter historically being the weakest due to weather conditions in North America, Europe and northern Asia that make roadway construction more difficult. Additionally, our international revenues have a significant large project component, resulting in a varying revenue stream. We expect the seasonality of our revenue and the fixed nature of our operating costs to continue in the foreseeable future. Therefore, we may be unable to adjust our spending in a timely manner to compensate for any unexpected revenue shortfall. As a result, if anticipated revenues in any quarter do not occur or are delayed, our operating results for the quarter would be disproportionately affected. Operating results also may fluctuate due to factors such as the demand for our products,products; product life cycle,cycle; the development, introduction and acceptance of new products and product enhancements by us or our competitors,competitors; changes in the mix of distribution channels through which our products are offered,offered; changes in the level of operating expenses,expenses; end user order deferrals in anticipation of new products,products; competitive conditions in the industry,industry; and economic conditions generally. No assurance can be given that we will be able to achieve or maintain profitability on a quarterly or annual basis in the future.
-17-Increased competition may make it difficult for us to acquire and retain end users. If we are unsuccessful in developing new applications and product enhancements, our products may become noncompetitive or obsolete.
Competition in the area of ITS, security and parking management is continuing to grow. Some of the companies that may compete with us in the business of developing and implementing traffic control and related security systems have substantially more financial, technological, marketing, personnel and research and development resources than we have. Therefore, they may be able to respond more quickly than we can to new or changing opportunities, technologies, standards or end user requirements. If we are unable to compete successfully with these companies, the market share for our products will decrease, and competitive pressures may seriously harm our business.
Additionally, the market for vehicle detection and ANPR is continuously seeking more advanced technological solutions to problems. Technologies such as embedded loop detectors, pressure plates, pneumatic tubes, radars, lasers, magnetometers, acoustics and microwaves that have been used as traffic sensing devices in the past are being enhanced for use in the traffic management industry, and new technologies may be developed. We are aware of several companies that are developing traffic management devices using machine vision technology or other advanced technology. Floating vehicle and/or radio frequency identification (RFID) tagged license plate initiatives are under consideration and may be implemented. We expect to face increasingly competitive product developments, applications and enhancements. New technologies or applications in traffic control systems from other companies may provide our end users with alternatives to our products and could render our solutions noncompetitive or obsolete. If we are unable to increase the number of our applications and develop and commercialize product enhancements and applications in a timely manner that respond to changing technology and satisfy the needs of our end users, our business and financial results will suffer.
AsOur dependence on third parties for manufacturing and marketing our products may prevent us from meeting customers’ needs in a timely manner.
We do not have, and do not intend to develop in the near future, internal capabilities to manufacture our products. We have entered into agreements with Econolite and Wireless Technology, Inc., or WTI, to manufacture the Autoscope system and related products for sales in North America, the Caribbean and Latin America. We work with suppliers, most of February 29, 2008, we had $5.5 million invested in auction rate securities. The auctions for these securities recently failed, which adversely affects their liquidity. If we must record an impairmentwhom are overseas, to manufacture the rest of our products. We also need to comply with the European Union’s regulatory RoHS directive on the recorded valuerestriction of the use of certain hazardous substances in electrical and electronic equipment. If Econolite, WTI or our other suppliers are unable to manufacture our products in the future, we may be unable to identify other manufacturers able to meet product and quality demands in a timely manner or at all. Our inability to find suitable manufacturers for our products could result in delays or reductions in product shipments, which in turn may harm our business reputation and results of operations. In addition, we have granted Econolite the exclusive right to market the Autoscope system and related products in North America, the Caribbean and Latin America. Consequently, our revenue depends to a significant extent on Econolite’s marketing efforts. Econolite’s inability to effectively market the Autoscope system, or the disruption or termination of that relationship, could result in reduced revenue and market share for our products.
We and our third party manufacturers obtain some of the components of our products from a single source, and an interruption in the supply of those components may prevent us from meeting customers’ needs in a timely manner and could therefore reduce our sales.
Although substantially all of the hardware components incorporated into our products are standard electronics components that are available from multiple sources, we and our third party manufacturers obtain some of the components from a single source. The loss or interruption of any of these securitiessupply sources could force us or recognize a loss on their disposition,our manufacturers to identify new suppliers, which could increase our costs, reduce our sales and profitability, or harm our customer relations by delaying product deliveries.
Some of our products are covered by our warranties, and, if the cost of fulfilling these warranties exceeds our warranty allowance, it could adversely affect our financial condition wouldand results of operations.
Unanticipated warranty and other costs for defective products could adversely affect our financial condition and results of operations and our reputation.We generally provide a two-year warranty on our product sales. These warranties require us to repair or replace faulty products, among other customary warranty provisions. Although we monitor our warranty claims and provide an allowance for estimated warranty costs, unanticipated claims in excess of the allowance could have a material adverse impact on our financial condition and results of operations. In addition, the need to repair or replace products with design or manufacturing defects could adversely affect our reputation.
We may face increased competition if we fail to adequately protect our intellectual property rights, and any efforts to protect our intellectual property rights may result in costly litigation.
Our success depends in large measure on the protection of our proprietary technology rights. We rely on trade secret, copyright and trademark laws, and confidentiality agreements with employees and third parties, all of which offer only limited protection. We have six patents related to RTMS technology and one patent related to CitySync technology. However, we cannot assure you that the scope of these or any future patents relating to our products will exclude competitors or provide competitive advantages to us. We also cannot assure you that we will become aware of all instances in which others develop similar products, duplicate any of our products, or reverse engineer or misappropriate our proprietary technology. If our proprietary technology is misappropriated, our business and financial results could be adversely affected. Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. In addition, we may be the subject of lawsuits by others who claim we violate their intellectual property rights. Even if the result is favorable, litigation could result in substantial costs and the diversion of management resources, either of which could harm our business.
We have not applied for patent protection in all countries in which we market and sell our products. Consequently, our proprietary rights in the technology underlying the Autoscope, RTMS and CitySync systems in countries other than the U.S. will be protected only to the extent that trade secret, copyright or other non-patent protection is available and to the extent we are able to enforce our rights. The laws of other countries in which we market our products may afford little or no effective protection of our proprietary technology, which could harm our business.
We plan to continue introducing new products and technologies and may not realize the degree or timing of benefits we initially anticipated, which could adversely affect our business and results of operations.
After December 31, 2007,We regularly invest substantial amounts in research and development efforts that pursue advancements in a range of technologies, products and services. Our ability to realize the anticipated benefits of these advancements depends on a variety of factors, including meeting development, production, certification and regulatory approval schedules; the execution of internal and external performance plans; the availability of supplier-produced parts and materials; the performance of suppliers and vendors; achieving cost efficiencies; the validation of innovative technologies; and the level of end user interest in new technologies and products. These factors involve significant risks and uncertainties. We may encounter difficulties in developing and producing these new products and may not realize the degree or timing of benefits initially anticipated. In particular, we investedcannot predict with certainty whether, when or in what quantities our current or potential end users will have a portiondemand for products currently in development or pending release. Moreover, as new products are announced, sales of current products may decrease as end users delay making purchases until such new products are available. Any of the foregoing could adversely affect our business and results of operations.
We price certain of our excess cash in auction rate securities and, as of February 29, 2008, we had $5.5 million of these securities in our investment portfolio. All of these auction rate securities have contractual maturities from 2031 to 2047. Further, all of these securities are collateralized by student loans, and approximately 97% of the collateral in the aggregate is guaranteed by the U.S. government under the Federal Family Education Loan Program. In February 2008, we experienced failed auctions for our entire auction rate securities portfolio, resulting in our inability to sell these securities in the short term. A failed auction results in a lack of liquidity in the securities but does not signify a default by the issuer. Upon an auction failure, the interest rates do not resetproducts at a market rate but instead reset based on a formula contained in the security, which generally is higher than the current market rate. Ifpremium compared to other technologies. As such, we need to access these funds, we willmay not be able to quickly respond to emerging low-cost competitors, and our inability to do so withoutcould adversely affect revenue and profitability.
We price certain of our products at a premium as compared to products using less sophisticated technologies. As the possible losstechnological sophistication of principal or until a future auctionour competitors and the size of the market increase, competing low-cost developers of machine vision products for these investments is successful, theytraffic are redeemedlikely to emerge and grow stronger. If end users prefer low-cost alternatives over our products, our revenue and profitability could be adversely affected.
Our revenue could be adversely affected by the issuer or they mature. We cannotemergence of local competitors and local biases in international markets.
Our experience indicates that local officials that purchase traffic management products in the international markets we serve favor products that are developed and manufactured locally. As local competitors to our products emerge, local biases could erode our revenue in Europe and Asia and adversely affect our sales and revenue in those markets.
Our failure to predict if or when a successful auction or redemption may take place.technological convergence could harm our business and could reduce our sales.
EIS is party to a lawsuit involving assets that Within our product families, we acquired from EIScurrently utilize only certain detection technologies available in December 2007.the ITS field. If the assets are determined to infringe a third party’s patent and EIS and its affiliateswe fail to fulfillpredict convergence of technology preferences in the market for ITS, or fail to identify and acquire complementary businesses or products that broaden our current product offerings, we may not capture certain segments of the market, which could harm our business and reduce our sales.
We sell our products internationally and are subject to various risks relating to such international activities, which could harm our international sales and profitability.
During 2010, 2009 and 2008, 37%, 25% and 28% of our total revenue, respectively, was attributable to international sales. By doing business in international markets, we are exposed to risks separate and distinct from those we face in our U.S. operations. Our international business may be adversely affected by changing economic conditions in foreign countries. Additionally fluctuations in currency exchange rates could affect demand for our products or otherwise negatively affect profitability. Engaging in international business inherently involves a number of other difficulties and risks, including:
• | export restrictions and controls relating to technology; | |
• | pricing pressure that we may experience internationally; | |
• | required compliance with existing and new foreign regulatory requirements and laws; | |
• | laws and business practices favoring local companies; | |
• | longer payment cycles; | |
• | difficulties in enforcing agreements and collecting receivables through foreign legal systems; | |
• | political and economic instability; | |
• | potentially adverse tax consequences, tariffs and other trade barriers; | |
• | international terrorism and anti-American sentiment; | |
• | difficulties and costs of staffing and managing foreign operations; and | |
• | difficulties in enforcing intellectual property rights. |
Our exposure to each of these risks may increase our costs, lengthen our sales cycle and require significant management attention. One or more of these factors may harm our business.
Our inability to comply with European and Asian regulatory restrictions over hazardous substances and electronic waste could restrict product sales in those markets and reduce profitability in the future.
The European Union has finalized the Waste Electrical and Electronic Equipment, or WEEE, directive, which makes producers of electrical goods financially responsible for specified collection, recycling, treatment and disposal of past and future covered products. This directive must now be enacted and implemented by individual European Union governments, and certain producers will be financially responsible under the WEEE legislation. This may impose requirements on us, which, if we are unable to meet them, could adversely affect our ability to market our products in European Union countries, and sales revenues and profitability would suffer as a consequence. In addition, the European Parliament has enacted a directive for the restriction of the use of certain hazardous substances in electrical and electronic equipment, or RoHS. This legislation restricts the use of such substances as mercury, lead, cadmium and hexavalent cadmium. If we are unable to have our products manufactured in compliance with the RoHS directive, we would be unable to market our products in European Union countries, and our revenues and profitability would suffer. In addition, various Asian governments could adopt their obligationown versions of environment-friendly electronic regulations similar to indemnify us orthe European directives, RoHS and WEEE. This could require new and unanticipated manufacturing changes, product testing and certification requirements, thereby increasing cost, delaying sales and lowering revenue and profitability.
Our inability to manage growth effectively could seriously harm our affiliates, or if our losses from the allegedly infringing technology exceed the obligationsbusiness.
Growth and expansion of EIS and its affiliates to indemnify us, our business could significantly strain our capital resources as well as the time and abilities of our management personnel. Our ability to manage growth effectively will require continued improvement of our operational, financial and management systems and the successful training, motivation and management of our employees. If we are unable to manage growth successfully, our business and operating results will suffer.
Our business operations will be severely disrupted if we lose key personnel or if we fail to attract and retain qualified personnel.
In 2005,Our technology depends upon the knowledge, experience and skills of our key management and scientific and technical personnel. Additionally, our ability to continue technological developments and to market our products, and thereby develop a third party sued EIS for patent infringement alleging infringement of the patent held by the third party on automatic lane calibration. The allegedly infringing technology is part of the assets we purchasedcompetitive edge in the EIS asset purchase.marketplace, depends in large part on our ability to attract and retain qualified scientific and technical personnel. Competition for qualified personnel is intense, and we cannot assure you that we will be able to attract and retain the individuals we need, especially if our business expands and requires us to employ additional personnel. In October 2007,addition, the court entered a final judgment dismissing the third party’s claimloss of patent infringement, but the third party could appeal the court’s order. Under the EIS asset purchase agreement, EIS agreed to defend this litigation at its own expense, we are not responsible for any liabilities of EIS or its affiliates arising before the closing of the EIS asset purchase on December 6, 2007, and EIS and its affiliates are obligated to indemnify us and our affiliates for any losses wepersonnel or our affiliates incur in connection with the litigation or disputed technology. However, if the EIS technology we acquired is finally determinedfailure to infringe the third party patenthire additional personnel could materially and EISadversely affect our business, operating results and its affiliates failability to satisfy their indemnification obligations to usexpand. The loss of key personnel, including Kenneth R. Aubrey, our President and Chief Executive Officer, or our affiliates, or ifinability to hire and retain qualified personnel, would harm our losses from the allegedly infringing technology exceed the obligation of EIS or its affiliates to indemnify us, our business could suffer.business.
Our stock is thinly traded and our stock price is volatile.
Our common stock is thinly traded, with 3,476,7813,468,301 shares of our 3,927,8064,880,619 outstanding shares held by non-affiliates as of March 1, 2008.February 28, 2011. Based on the trading history of our common stock and the nature of the market for publicly traded securities of companies in evolving high-tech industries, we believe there are several factors that have caused and are likely to continue to cause the market price of our common stock to fluctuate substantially. The fluctuations may occur on a day-to-day basis or over a longer period of time. Factors that may cause fluctuations in our stock price include announcements of large orders obtained by us or our competitors, substantial cutbacks in government funding of highway projects or of the potential availability of alternative technologies for use in traffic control and safety, quarterly fluctuationfluctuations in our financial results or the financial results of our competitors, consolidation among our competitors, fluctuations in stock market prices and volumes, and the volatility of the stock market.
-18-
We may not be successful in implementing our acquisition strategy. Future acquisitions could result in disruptions to our business by, among other things, distracting management time and diverting financial resources. Further, if we are unsuccessful in integrating acquired companies into our business itwhich could materially and adversely affect our financial condition and operating results.
Part of our continuing business strategy ishas been to acquire or invest in companies, products or technologies that complement our current products, enhance our market coverage or technical capabilities or offer growth opportunities. As part of this strategy, in December 2007, we completed the EIS asset purchase. We may not be able to identify suitable acquisition candidates or investment partners or productspurchase and in the future or, ifJune 2010, we do, we may not be able to make such acquisitions on commercially acceptable terms or at all.acquired CitySync Limited. For any acquisitions, including the EIS asset purchase,acquisition, a significant amount of management’s time and financial resources may be required to complete the acquisition and integrate the acquired business into our existing operations. Even with this investment of management time and financial resources, an acquisition including the EIS asset purchase, may not produce the revenue, earnings or business synergies anticipated. Acquisitions involve numerous other risks, including the assumption of unanticipated operating problems or legal liabilities,liabilities; problems integrating the purchased operations, technologies or products,products; the diversion of management’s attention from our core businesses,businesses; restrictions on the manner in which we may use purchased companies or assets imposed by acquisition agreements,agreements; adverse effects on existing business relationships with suppliers and customers,customers; incorrect estimates made in the accounting for acquisitions and amortization of acquired intangible assets that would reduce future reported earnings (such as goodwill impairments),; ensuring acquired companies’ compliance with the requirements of the Sarbanes-Oxley Act,Act; and the potential loss of customers or key employees of acquired businesses. We cannot assure you that any acquisitions, investments, strategic alliances or joint ventures including the EIS asset purchase, will be completed or integrated in a timely manner or achieve anticipated synergies, will be structured or financed in a way that will enhance our business or creditworthiness, or will meet our strategic objectives or otherwise be successful.
Amounts recorded for goodwill could be adversely impacted by current market conditions.
Our recorded goodwill of approximately $14.7 million at December 31, 2010 relates to our Hong Kong-based subsidiary, Flow Traffic Ltd., the EIS asset purchase and the CitySync acquisition. Each year, we perform an impairment test of goodwill in October for the EIS assets and in December for Flow Traffic or whenever an impairment indicator arises, and we test our long-lived assets for impairment when indicators of impairment are present. We plan to test CitySync annually beginning with April 2011. The impairment test requires us to estimate the fair value of our reporting units and then compare it to the carrying value of the reporting units. If the carrying value exceeds the fair value, further analysis is performed to determine if there is an impairment charge. We estimate the fair value primarily by using a combination of income and market approaches, where fair value under the income approach is dependent on the present value of future economic benefits to be derived from the reporting units and fair value under the market approach considers recently completed transactions within our industry sectors, comparable trading values and other market conditions. The future economic benefits are significantly dependent on future revenue growth. If the reporting units do not provide the future economic benefits we project, the fair value of these assets may become impaired, and we would need to record an impairment loss. Fair market valuation requires assumptions and estimates of many critical factors, including revenue and market growth, operating cash flows, market multiples and discount rates. As general market conditions have deteriorated, our reporting units could experience a decline in fair market value, which could adversely affect the results of the impairment testing that we perform in the future and could potentially lead to a future impairment charge of some or all of our goodwill at one or all of our reporting units. In addition, ongoing financial market turmoil could impact common stock trading prices for many companies, including ours. If our market capitalization falls below our shareholders’ equity, it could trigger an impairment of goodwill in the future.
Difficult and volatile conditions in the capital, credit and commodities markets and in the overall economy could continue to adversely affect our financial position, results of operations and cash flows, and we maydo not know if these conditions will improve in the near future.
Our financial position, results of operations and cash flows could continue to be able to secureadversely affected by difficult conditions and significant volatility in the financing necessary to consummate future acquisitions,capital, credit and future acquisitionscommodities markets and investments could involvein the issuanceoverall worldwide economy. These factors, combined with declining business and consumer confidence and increased unemployment, have precipitated a worldwide economic slowdown and recession in the United States and other parts of additional equity securitiesthe world. The continuing impact that these factors might have on us and our business is uncertain and cannot be estimated at this time. Current economic conditions have accentuated each of these risks and magnified their potential effect on us and our business. The difficult conditions in these markets and the overall economy affect our business in a number of ways. For example:
• | Although we believe we have sufficient liquidity under our financing arrangement with Associated Bank, National Association, to run our business, under extreme market conditions, there can be no assurance that such funds would be available or sufficient, and, in such a case, we may not be able to successfully obtain additional financing on favorable terms, or at all. | |
• | Recent market volatility has exerted downward pressure on our stock price, which may make it more difficult or unfavorable for us to raise additional capital in the future. | |
• | Economic conditions could result in customers in our markets continuing to experience financial difficulties or electing to limit spending because of the economy which may result, for example, in declining tax revenue for our customers that are governmental entities, which in turn could result in decreased sales and earnings for us. |
We do not know if market conditions or the incurrencestate of additional debt, which could increase dilutionthe overall economy will improve in the near future, when improvement will occur or harmif any improvement will benefit our financial condition or creditworthiness.market segment.
Our directors and executive officers have substantial controlinfluence over us and could limit the ability of our other shareholders to influenceaffect the outcome of key transactions, including changes of control.
Our executive officers and directors and entities affiliated with them, in the aggregate, beneficially owned 11% of our outstanding common stock as of March 1, 2008.24, 2011, assuming the exercise by them of all of their options that were currently exercisable or that vest within 60 days of March 24, 2011. Our executive officers and directors and their affiliated entities, if acting together, thus are able to control or influence significantly all matters requiring approval by our shareholders, including the election of directors and the approval of mergers or other significant corporate transactions. These shareholders may have interests that differ from other shareholders, and they may vote in a way with which other shareholders disagree and that may be adverse to other shareholders’ interests. The concentration of ownership of our common stock may have the effect of delaying, preventing or deterring a change of control of our company, could deprive our shareholders of an opportunity to receive a premium for their common stock as part of a sale of our company, and may affect the market price of our common stock. This concentration of ownership of our common stock may also have the effect of influencing the completion of a change in control that may not necessarily be in the best interests of all of our shareholders.
Our articles of incorporation and bylaws and Minnesota law and the terms of the EIS asset purchase agreement may inhibit a takeover that shareholders consider favorable.
Provisions of our articles of incorporation and bylaws and applicable provisions of Minnesota law may delay or discourage transactions involving an actual or potential change in our control or change in our management, including transactions in which shareholders might otherwise receive a premium for their shares or transactions that our shareholders might otherwise deem to be in their best interests. These provisions:
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| • | permit our board of directors to issue up to 5,000,000 shares of preferred stock with any rights, preferences and privileges as it may designate, including the right to approve an acquisition or other change in our control; |
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| • | provide that the authorized number of directors may be changed by resolution of the board of directors; |
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| • | provide that all vacancies, including newly-created directorships, may, except as otherwise required by law, be filled by the affirmative vote of a majority of directors then in office, even if less than a quorum; and |
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| • | eliminate cumulative voting rights, therefore allowing the holders of a majority of the shares of common stock entitled to vote in any election of directors to elect all of the directors standing for election, if they should so choose. |
In addition, Section 302A.671 of the Minnesota Business Corporation Act, or MBCA, generally limits the voting rights of a shareholder acquiring a substantial percentage of our voting shares in an attempted takeover or otherwise becoming a substantial shareholder of our company unless holders of a majority of the voting power of the disinterested shares approve full voting rights for the substantial shareholder. Section 302A.673 of the MBCA generally limits our ability to engage in any business combination with certain persons who own 10% or more of our outstanding voting stock or any of our associates or affiliates who at any time in the past four years have owned 10% or more of our outstanding voting stock. These provisions of the MBCA may have the effect of entrenching our management team and may deprive shareholders of the opportunity to sell their shares to potential acquirers at a premium over prevailing prices. This potential inability to obtain a control premium could reduce the price of our common stock.
The EIS asset purchase agreement also accelerates earn-out payments we must make to EIS if we are acquired or sell substantially all of our assets before December 6, 2010. The required acceleration of these payments could negatively affect the ability of our shareholders to obtain a premium over our prevailing stock price and reduce our stock price generally.
We can issue shares of preferred stock without shareholder approval, which could adversely affect the rights of common shareholders.
Our articles of incorporation permit our board of directors to establish the rights, privileges, preferences and restrictions, including voting rights, of future series of our preferred stock and to issue such stock without approval from our shareholders. The rights of holders of our common stock may suffer as a result of the rights granted to holders of preferred stock that may be issued in the future. In addition, we could issue preferred stock to prevent a change in control of our company, depriving common shareholders of an opportunity to sell their stock at a price in excess of the prevailing market price.
We do not intend to declare dividends on our stock in the foreseeable future.
We currently intend to retain all future earnings for the operation and expansion of our business and, therefore, do not anticipate declaring or paying cash dividends on our common stock in the foreseeable future. Any payment of cash dividends on our common stock will be at the discretion of our board of directors and will depend upon our operating results, earnings, current and anticipated cash needs, capital requirements, financial condition, future prospects, any contractual restrictions and any other factors deemed relevant by our board of directors. Therefore, shareholders should not expect to receive dividend income from shares of our common stock.
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Unresolved Staff Comments |
None.
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Properties |
We currently lease and occupy 11,564approximately 20,000 square feet in St. Paul, Minnesota for our headquarters. This lease expires onin May 31, 2010,2014, and we have the right to renew the lease for two additional three-year terms. Our office in Toronto, Ontario, Canadasuburban north London, United Kingdom consists of approximately 6,20017,000 square feet of space, and our lease for this space expires at our option in December 2010.January 2015. We also lease smaller facilities in Canada, Hong Kong, the United KingdomChina and Poland. We believe that our facilities are adequate to meet our current and expected needs.
-20-
We believe that our current space is generally adequate in the United States, Asia and Europe, and we do not intend to lease significantly more space in 2008.2011.
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Legal Proceedings |
We are involved in legal actions and claims relating to various matters. Although we are unable to predict the ultimate outcome of these legal actions and claims, it is the opinion of management that the disposition of these matters, taken as a whole, will not currentlyhave a party to any material pending legal proceedings.adverse effect on our consolidated financial statements.
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None.
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Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
Market Information
Our common stock is traded on The NASDAQ Capital Market under the symbol “ISNS.” The quarterly high and low sales prices for our common stock for our last two fiscal years are set forth below.
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Quarter |
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First |
| $ | 18.90 |
| $ | 13.70 |
| $ | 13.50 |
| $ | 11.44 |
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| $ | 15.53 |
| $ | 11.50 |
| $ | 10.51 |
| $ | 6.69 |
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Second |
| 19.70 |
| 14.86 |
| 14.91 |
| 11.50 |
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| 12.20 |
| 10.25 |
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Third |
| 16.74 |
| 11.56 |
| 14.25 |
| 11.25 |
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| 10.10 |
| 13.11 |
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Fourth |
| 18.54 |
| 11.65 |
| 14.57 |
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| 11.10 |
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Shareholders
As of February 20, 2008,28, 2011, there were 2225 holders of record of our common stock and approximately 1,868 beneficialstock. The number of holders of our common stock.record is based upon the actual number of holders registered at such date and does not include holders of shares in “street names” or persons, partnerships, associates, corporations, or other entities identified in security position listings maintained by depositories.
Dividends
We have never declared or paid a cash dividend on our common stock. We currently intend to retain earnings for use in the operation and expansion of our business, and, consequently, we do not anticipate paying any dividends in the foreseeable future.
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Comparative Stock Performance Graph
The graph below compares the five-year cumulative total stockholder return on our common stock with the cumulative total stockholder return of (i) the Dow Jones Wilshire 5000 Index and (ii) the Dow Jones Wilshire Electronic Equipment Index, assuming an investment of $100 on December 31, 2002,2005, including reinvestment of dividends.
Notwithstanding anything to the contrary set forth in any of our previous or future filings under the Securities Act of 1933 or the Securities Exchange Act of 1934 that might incorporate future filings by reference, including this Annual Report on Form 10-K, in whole or in part, the following performance graph and accompanying data shall not be deemed to be incorporated by reference into any such filings and shall not otherwise be deemed filed under such Acts.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among Image Sensing Systems, Inc., The Dow JonesInc, the Wilshire 5000 IndexAnd Theand the Dow Jones Wilshire ElectronicUS Electrical Components & Equipment TSM Index
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Image Sensing Systems, Inc |
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| 100.00 |
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| 107.35 |
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| 130.28 |
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| 47.75 |
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| 85.46 |
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| 97.53 |
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Wilshire 5000 |
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| 100.00 |
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| 115.77 |
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| 122.27 |
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| 76.75 |
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| 98.47 |
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| 115.37 |
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Dow Jones US Electrical Components & Equipment TSM |
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| 100.00 |
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| 113.96 |
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| 135.86 |
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| 72.41 |
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| 111.44 |
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| 139.51 |
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Image Sensing Systems, Inc. |
| $ | 100.00 |
| $ | 230.07 |
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| $ | 303.87 |
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| $ | 395.90 |
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Dow Jones Wilshire 5000 |
| $ | 100.00 |
| $ | 131.64 |
| $ | 148.26 |
| $ | 157.64 |
| $ | 182.66 |
| $ | 193.13 |
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Dow Jones Wilshire Electronic Equipment |
| $ | 100.00 |
| $ | 165.34 |
| $ | 176.81 |
| $ | 186.40 |
| $ | 214.79 |
| $ | 249.70 |
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Selected Financial Data |
The following table sets forth selected consolidated financial data for each of the five fiscal years ended December 31, 2007.2010. The statement of income and balance sheet data for the years ended and as of December 31, 2010, 2009, 2008, 2007 2006, 2005, 2004 and 20032006 are derived from our audited consolidated financial statements. The following information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and with our consolidated financial statements and the related notes thereto included elsewhere in this report.
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| Fiscal Years Ended December 31, |
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Consolidated Statement of Income Data: |
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Revenue: |
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| $ | 4,067 |
| $ | 2,980 |
| $ | 2,407 |
| $ | 3,309 |
| $ | 3,339 |
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North American sales |
| 269 |
| — |
| — |
| — |
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Product sales |
| $ | 19,162 |
| $ | 12,483 |
| $ | 13,144 |
| $ | 4,336 |
| $ | 2,980 |
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Royalties |
| 10,747 |
| 10,136 |
| 8,595 |
| 7,521 |
| 5,920 |
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| 12,519 |
| 12,110 |
| 13,321 |
| 10,747 |
| 10,136 |
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Total revenue |
| 15,083 |
| 13,116 |
| 11,002 |
| 10,830 |
| 9,259 |
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| 31,681 |
| 24,593 |
| 26,465 |
| 15,083 |
| 13,116 |
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Cost of revenue: |
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International sales |
| 1,927 |
| 1,501 |
| 1,042 |
| 1,599 |
| 1,533 |
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North American sales |
| 60 |
| — |
| — |
| — |
| — |
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Product sales |
| 7,799 |
| 4,297 |
| 4,912 |
| 1,987 |
| 1,501 |
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Royalties |
| — |
| 220 |
| 383 |
| 321 |
| 277 |
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| — |
| — |
| — |
| 220 |
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Total cost of revenue |
| 1,987 |
| 1,721 |
| 1,425 |
| 1,920 |
| 1,810 |
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| 7,799 |
| 4,297 |
| 4,912 |
| 1,987 |
| 1,721 |
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|
|
|
|
|
|
|
| ||||||||||||||||||||
Gross profit |
| 13,096 |
| 11,395 |
| 9,577 |
| 8,910 |
| 7,449 |
|
| 23,882 |
| 20,296 |
| 21,553 |
| 13,096 |
| 11,395 |
| ||||||||||
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||
Selling, marketing and product support |
| 3,463 |
| 2,850 |
| 2,567 |
| 2,523 |
| 2,536 |
|
| 9,807 |
| 7,201 |
| 6,680 |
| 3,463 |
| 2,850 |
| ||||||||||
General and administrative |
| 2,653 |
| 2,383 |
| 1,400 |
| 1,317 |
| 1,235 |
|
| 4,372 |
| 3,779 |
| 4,069 |
| 2,653 |
| 2,383 |
| ||||||||||
Research and development |
| 2,299 |
| 2,639 |
| 1,516 |
| 1,126 |
| 730 |
|
| 3,630 |
| 3,336 |
| 2,908 |
| 2,299 |
| 2,639 |
| ||||||||||
Amortization of intangible assets(1) |
| 51 |
| — |
| — |
| — |
| — |
| |||||||||||||||||||||
In-process research and development(1) |
| 4,500 |
| — |
| — |
| — |
| — |
| |||||||||||||||||||||
Amortization of intangible assets |
| 1,218 |
| 768 |
| 768 |
| 51 |
| — |
| |||||||||||||||||||||
Acquisition related expenses |
| 817 |
| — |
| — |
| — |
| — |
| |||||||||||||||||||||
In-process research and development |
| — |
| — |
| — |
| 4,500 |
| — |
| |||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||||||
|
| 12,966 |
| 7,871 |
| 5,483 |
| 4,966 |
| 4,501 |
|
| 19,844 |
| 15,084 |
| 14,425 |
| 12,966 |
| 7,871 |
| ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||||||
Income from operations |
| 130 |
| 3,524 |
| 4,094 |
| 3,944 |
| 2,948 |
|
| 4,038 |
| 5,212 |
| 7,128 |
| 130 |
| 3,524 |
| ||||||||||
Other income, net |
| 543 |
| 523 |
| 252 |
| 102 |
| 23 |
| |||||||||||||||||||||
Other income (expense), net |
| (123 | ) |
| 7 |
| 43 |
| 543 |
| 523 |
| ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||||||
Income before income taxes |
| 673 |
| 4,047 |
| 4,346 |
| 4,046 |
| 2,971 |
|
| 3,915 |
| 5,219 |
| 7,171 |
| 673 |
| 4,047 |
| ||||||||||
Income tax expense (benefit) |
| (199 | ) |
| 942 |
| 1,505 |
| 1,352 |
| 836 |
|
| 910 |
| 1,354 |
| 2,207 | ) |
| (199 | ) |
| 942 |
| |||||||
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||||||||||
Net income |
| $ | 872 |
| $ | 3,105 |
| $ | 2,841 |
| $ | 2,694 |
| $ | 2,135 |
|
| $ | 3,005 |
| $ | 3,865 |
| $ | 4,964 |
| $ | 872 |
| $ | 3,105 |
|
|
|
|
|
|
|
|
|
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|
|
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| ||||||||||||||||||||
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|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||
Net income per share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||
Basic |
| $ | 0.23 |
| $ | 0.83 |
| $ | 0.79 |
| $ | 0.79 |
| $ | 0.66 |
|
| $ | 0.66 |
| $ | 0.97 |
| $ | 1.26 |
| $ | 0.23 |
| $ | 0.83 |
|
Diluted |
| 0.22 |
| 0.80 |
| 0.73 |
| 0.71 |
| 0.60 |
|
| 0.64 |
| 0.95 |
| 1.24 |
| 0.22 |
| 0.80 |
| ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||
Weighted average number of common shares outstanding: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||
Basic |
| 3,789 |
| 3,725 |
| 3,602 |
| 3,409 |
| 3,215 |
|
| 4,555 |
| 3,985 |
| 3,943 |
| 3,789 |
| 3,725 |
| ||||||||||
Diluted |
| 3,881 |
| 3,891 |
| 3,868 |
| 3,810 |
| 3,598 |
|
| 4,667 |
| 4,081 |
| 4,001 |
| 3,881 |
| 3,891 |
| ||||||||||
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|
|
|
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|
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| |||||||||||||||||||||
|
|
|
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
| At December 31, |
| |||||||||||||
|
|
| ||||||||||||||
|
| 2007 |
| 2006 |
| 2005 |
| 2004 |
| 2003 |
| |||||
|
|
|
|
|
|
| ||||||||||
|
| (in thousands) |
| |||||||||||||
Consolidated Balance Sheet Data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets(1) |
| $ | 30,388 |
| $ | 21,224 |
| $ | 16,791 |
| $ | 13,063 |
| $ | 9,587 |
|
Bank debt(1) |
|
| 5,000 |
|
| — |
|
| — |
|
| — |
|
| — |
|
Total shareholders’ equity |
|
| 23,225 |
|
| 19,333 |
|
| 15,722 |
|
| 11,779 |
|
| 7,760 |
|
|
|
-24-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| At December 31, |
| |||||||||||||
|
|
| ||||||||||||||
|
| 2010 |
| 2009 |
| 2008 |
| 2007 |
| 2006 |
| |||||
|
|
| ||||||||||||||
|
| (in thousands) |
| |||||||||||||
Consolidated Balance Sheet Data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
| $ | 54,356 |
| $ | 41,150 |
| $ | 36,108 |
| $ | 30,388 |
| $ | 21,224 |
|
Bank debt |
|
| — |
|
| 4,000 |
|
| 3,750 |
|
| 5,000 |
|
| — |
|
Total shareholders’ equity |
|
| 46,021 |
|
| 32,713 |
|
| 28,530 |
|
| 23,225 |
|
| 19,333 |
|
|
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations |
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the Selected Financial Data and our financial statements and the accompanying notes.notes included elsewhere in this Annual Report. Our actual results could differ materially from those anticipated in the forward-looking statements included in this discussion as a result of certain factors, including, but not limited to, those discussed in “Risk Factors” and “Information Regarding Forward-Looking Statements” included elsewhere in this Annual Report.
Overview
General.. We provide software-basedsoftware based computer enabled detection, or CED, products and solutions that use advanced signal processing software algorithms to detect and monitor objects in a designated field of view. Our technology analyzes the signal from a sophisticated sensor and passes the information along to management systems, controllers or directly to users. Our core products, the Autoscope® Video Vehicle Detection System, and the RTMS® Radar Detection System and CitySync Automatic Number Plate Recognition (ANPR) System, operate using our proprietary application software in conjunction with video cameras or radar and commonly available electronic components. Each of theseOur systems isare used by traffic managers primarily to improve the flow of vehicle traffic and to enhance safety at intersections, main thoroughfares, freeways and tunnels.tunnels and by parking and toll managers and law enforcement officials to read license plates for various safety, security, access and enforcement ANPR applications.
Autoscope systems are sold to distributors and end users of traffic management products in North America, the Caribbean and Latin America by Econolite Control Products, Inc., or Econolite, our exclusive licensee in these regions. We sell RTMS and CitySync systems are sold to distributors and end users in North America. We also sell both Autoscope and RTMSall of our systems to distributors and end users in Europe and Asia through our European and Hong Kong subsidiaries, respectively. End usersThe majority of our products throughout the worldsales are generallyto end users that are funded by government agencies responsible for traffic management or traffic law enforcement.
CitySync Acquisition. In June 2010, we purchased all of the outstanding equity of CitySync Limited through which we own its principal product line, the CitySync ANPR system. We believe the CitySync acquisition expands our addressable market, strengthens our selling presence in Europe and extends our opportunities for hybrid product developments. In its fiscal year ended January 31, 2010, CitySync had revenue of $7.4 million, substantially all of which related to ANPR system sales.
EIS Asset Purchase.On December 6, In 2007, we purchased certain assets from EIS Electronic Integrated Systems Inc., or EIS, including its principal product line, the RTMS system. In its fiscal year ended September 30, 2007, EIS had revenue of $8.7 million, substantially all of which related to RTMS sales. Our consolidated financial statements include revenue and expenses related to
Trends and Challenges in Our Business | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
We believe the
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We believe our continued growth primarily depends upon:
Because the majority of our Key Financial Terms and Metrics Cost of Revenue. There is no cost of revenue related to Operating Reconciliations of GAAP net income to non-GAAP net income are as follows (dollars in thousands, except per share amounts):
Seasonality. Our quarterly revenues and operating results have varied significantly in the past due to the seasonality of our business. Our first quarter generally is the weakest due to weather conditions that make roadway construction more difficult in North America, Europe and northern Asia. We expect such seasonality to continue for the foreseeable future. Additionally, our international revenues have a significant large project component, resulting
in a varying revenue stream. Accordingly, we believe that quarter-to-quarter comparisons of our financial results should not be relied upon as an indication of our future performance. No assurance can be given that we will be able to achieve or maintain profitability on a quarterly or annual basis in the future. History.We were incorporated in the state of Minnesota in December 1984 and began operations by pioneering the commercial application of wide-area video vehicle detection for traffic management. The technology underlying our products was initially developed at the University of Minnesota. In 1989, the University was awarded a patent for that technology, which it exclusively licensed to us. In 1991, we sub-licensed this technology to Econolite, a leading manufacturer and seller of traffic control products in North America and the Caribbean, to manufacture and distribute products incorporating the technology. Segments. We currently operate in three reportable segments: Autoscope, RTMS and CitySync. Autoscope is our machine-vision product line, and revenue consists of royalties (all of which are received from Econolite), as well as a portion of international sales. RTMS is our radar product line acquired in the EIS asset purchase in December 2007. CitySync is our ANPR product line acquired in the CitySync purchase in June 2010. All segment revenues are derived from external customers. Due to the CitySync acquisition and related changes in how we manage our business, we may reevaluate our segment definitions in the future. The following tables set forth selected unaudited financial information for each of the Company’s reportable segments (in thousands):
The CitySync segment loss before income taxes includes $817,000 of acquisition related expenses. Results of Operations The following table sets forth, for the periods indicated, certain statements of income data as a percent of total revenue and gross margin on international sales and royalties as a percentage of international sales and royalties, respectively.
Year Ended December 31, Gross margins for Selling, marketing and product support expense increased to
General and administrative expense increased to Research and development expense Amortization of intangibles expense was
Other income (expense) was an expense of Income before income taxes for the
Our income tax effective rate was
Year Ended December 31, Gross margins for Selling, marketing and product support expense increased to General and administrative expense Research and development expense increased to Amortization of intangibles expense was $768,000 in 2009 and Other income Income before income taxes for the Autoscope segment decreased to $3.8 million in 2009 from $5.9 million in 2008, a decrease of 35.9%. The decrease was mainly due to lower gross margins and higher Our income tax effective rate Liquidity and Capital Resources At December 31, Table of Net cash provided by operating activities was In December We also have
May 1, 2012. We believe that In conjunction with our In conjunction with our EIS asset purchase, the sellers had an earn-out arrangement over approximately three years from the December 2007 date of purchase. The earn-out ended as of December 31, 2010. The earn-out was based on earnings before taxes from RTMS sales less related cost of revenue and operating expenses, excluding depreciation, amortization and interest expenses, and was calculated annually. For the first two earn-out periods, the sellers of the EIS assets received a total of $2.7 million in earn-out payments. Based on the 2010 results, the sellers are entitled to receive a $1.7 million earn-out for We believe that cash and cash equivalents on hand at December 31, 2010, along with the availability of funds under our $5.0 million revolving line of credit and cash provided by Off-Balance Sheet Arrangements We do not participate in transactions or have relationships or other arrangements with an unconsolidated entity, including special purpose and similar entities or other off-balance sheet arrangements. Critical Accounting Policies Goodwill and Intangible Assets.Goodwill is not amortized but is tested for impairment annually or whenever an impairment indicator arises. Our On an annual basis, we reconcile our market value to For Flow Traffic, we estimate the fair value by using a combination of the income approach, where fair value is dependent on the present value of future economic benefits to be derived from ownership of Flow
Earn-outs related to the EIS asset purchase Revenue Recognition.Royalty income is recognized based upon a monthly royalty report provided to us by Econolite. This report is prepared by Econolite based on its sales of products we developed and is based on sales shipped or delivered Income Taxes.Income taxes are accounted for under the liability method. Deferred income taxes reflect the effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and amounts used for income tax purposes. Deferred tax assets are offset by a valuation allowance as deemed necessary based on our estimate of our future sources of taxable income and the expected timing of temporary difference reversals. Uncertain tax positions are recognized if the tax position is more likely than not of being sustained on audit based on the technical merits of the position. Inventories.Inventories are stated at the lower of cost (first-in, first-out method) or market and allowances have been made for obsolete, excess or unmarketable inventories based on estimated future usage or actual or anticipated product line changes. Warranties. We generally provide a standard two-year warranty on product sales. Reserves to honor warranty claims are estimated and recorded at the time of sale based on historical claim information and are analyzed and adjusted periodically based on claim trends. New and Recently Adopted Accounting Pronouncements In In September
Our foreign sales and results of operations are subject to the impact of foreign currency fluctuations.
IMAGE SENSING SYSTEMS, INC.
See accompanying notes to the consolidated financial statements.
IMAGE SENSING SYSTEMS, INC.
See accompanying notes to the consolidated financial statements.
Years ended December 31 2010 2009 2008 Operating activities: Net income $ 3,005 $ 3,865 $ 4,964 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 498 424 357 Amortization 1,218 768 768 Tax benefit from disqualifying disposition 72 — 137 Stock option expense 342 341 339 Deferred income taxes 174 138 (133 ) Changes in operating assets and liabilities, net of acquisition: Accounts receivable (3,711 ) 960 (1,623 ) Inventories (1,309 ) (1,126 ) (29 ) Prepaid expenses and other receivables (1,229 ) (212 ) (148 ) Accounts payable 391 702 (565 ) Accrued liabilities 832 (384 ) 671 Income taxes payable (250 ) (87 ) 445 Net cash provided by operating activities 33 5,389 5,183 Investing activities: Cash paid to sellers of CitySync equity (7,871 ) — — Repayment of CitySync seller loans (445 ) — — EIS earn-out payment (1,541 ) (1,192 ) — Purchase of short-term investments (8,882 ) (6,640 ) (7,400 ) Sale of short-term investments 8,863 6,705 3,400 Purchases of property and equipment (380 ) (694 ) (385 ) Net cash used in investing activities (10,256 ) (1,821 ) (4,385 ) Financing activities: Net proceeds from common stock offering 8,818 — — Proceeds from exercise of stock options 121 1 173 Proceeds from bank debt — 4,000 — Repayment of bank debt (4,556 ) (3,750 ) (1,250 ) Cash released from restriction on bank debt — — 5,263 Net cash provided by financing activities 4,383 251 4,186 Effect of exchange rate changes on cash (223 ) 24 (308 ) Increase (decrease) in cash and cash equivalents (6,063 ) 3,795 4,676 Cash and cash equivalents at beginning of year 14,084 10,289 5,613 Cash and cash equivalents at end of year $ 8,021 $ 14,084 $ 10,289 Supplemental disclosure: Income taxes paid $ 1,571 $ 1,488 $ 1,680 Interest expense paid $ 155 $ 33 $ 278 Supplemental non-cash disclosure: Common stock issued in connection with CitySync acquisition $ 727 $ — $ — EIS earn-out payable recorded as additional goodwill $ 1,665 $ 1,541 $ 1,164 See accompanying notes to the consolidated financial statements. Year ended December 31 2007 2006 2005 Operating activities: Net income $ 872 $ 3,105 $ 2,841 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 226 226 121 Amortization 51 162 258 In-process research and development 4,500 — — Tax benefit from disqualifying disposition 112 113 377 Stock option expense 194 177 68 Deferred income taxes (1,653 ) (203 ) (57 ) Changes in operating assets and liabilities: Accounts receivable (2,040 ) 557 (1,338 ) Inventories (909 ) (358 ) 92 Prepaid expenses (102 ) (22 ) 41 Accounts payable 200 218 (4 ) Accrued liabilities 177 511 (183 ) Income taxes payable (147 ) 137 194 Net cash provided by operating activities 1,481 4,623 2,410 Investing activities: Purchase of EIS assets (11,406 ) — — Purchase of short-term investments — (1,800 ) — Sale of short-term investments 1,800 — 5,000 Maturity of callable FHLB bonds 2,300 — — Purchases of property and equipment (104 ) (419 ) (323 ) Net cash provided by (used in) investing activities (7,410 ) (2,219 ) 4,677 Financing activities: Proceeds from exercise of stock options 34 200 657 Proceeds from bank borrowing 5,000 — — Cash restricted for bank borrowing (5,263 ) — — Net cash provided by (used in) financing activities (229 ) 200 657 Effect of exchange rate changes on cash 145 16 — Increase (decrease) in cash and cash equivalents (6,013 ) 2,620 7,744 Cash and cash equivalents at beginning of year 11,626 9,006 1,262 Cash and cash equivalents at end of year $ 5,613 $ 11,626 $ 9,006 Supplemental disclosure: Income taxes paid $ 1,352 $ 1,025 $ 933 Supplemental non-cash disclosure: Common stock issued in connection with EIS asset purchase $ 2,534 $ — $ — IMAGE SENSING SYSTEMS, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (in thousands, except share data) Shares Common Additional Accumulated Retained Total Balance at December 31, 2007 3,927,806 $ 39 $ 11,004 $ 161 $ 12,021 $ 23,225 Tax benefit from disqualifying disposition — — 137 — — 137 Common stock issued for options exercised 59,000 1 194 — — 195 Common stock retired (1,587 ) — (22 ) — — (22 ) Stock option expense — — 339 — — 339 Foreign currency translation adjustment — — — (308 ) — (308 ) Net income — — — — 4,964 4,964 Comprehensive income — — — — — 4,656 Balance at December 31, 2008 3,985,219 40 11,652 (147 ) 16,985 28,530 Common stock issued for options exercised 600 — 1 — — 1 Stock option expense — — 341 — — 341 Foreign currency translation adjustment — — — (24 ) — (24 ) Net income — — — — 3,865 3,865 Comprehensive income — — — — — 3,841 Balance at December 31, 2009 3,985,819 40 11,994 (171 ) 20,850 32,713 Tax benefit from disqualifying disposition — — 72 — — 72 Common stock issued for options exercised 37,700 — 121 — — 121 Common stock issued in secondary offering, net 798,000 8 8,810 — — 8,818 Common stock issued in CitySync acquisition 57,000 1 726 — — 727 Stock option expense — — 342 — — 342 Foreign currency translation adjustment — — — 223 — 223 Net income — — — — 3,005 3,005 Comprehensive income — — — — — 3,228 Balance at December 31, 2010 4,878,519 $ 49 $ 22,065 $ 52 $ 23,855 $ 46,021 See accompanying notes to the consolidated financial statements. Shares Common Additional Accumulated Retained Total Balance at December 31, 2004 3,537,222 $ 35 $ 6,541 $ — $ 5,203 $ 11,779 Tax benefit from disqualifying disposition — — 377 — — 377 Common stock issued for options exercised 164,783 2 655 — — 657 Stock option expense — — 68 — — 68 Net income — — — — 2,841 2,841 Balance at December 31, 2005 3,702,005 37 7,641 — 8,044 15,722 Tax benefit from disqualifying disposition — — 113 — — 113 Common stock issued for options exercised 59,799 1 199 — — 200 Stock option expense — — 177 — — 177 Foreign currency translation adjustment — — — 16 — 16 Net income — — — — 3,105 3,105 Comprehensive income — — — — — 3,121 Balance at December 31, 2006 3,761,804 38 8,130 16 11,149 19,333 Tax benefit from disqualifying disposition — — 112 — — 112 Common stock issued for options exercised 18,800 — 34 — — 34 Common stock issued in EIS asset purchase 147,202 1 2,534 — — 2,535 Stock option expense — — 194 — — 194 Foreign currency translation adjustment — — — 145 — 145 Net income — — — — 872 872 Comprehensive income — — — — — 1,017 Balance at December 31, 2007 3,927,806 $ 39 $ 11,004 $ 161 $ 12,021 $ 23,225 Notes to Consolidated Financial Statements December 31, 1. DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF BUSINESS Image Sensing Systems, Inc. (referred to herein as “we,” the “Company,” “us” and “our”) develops and markets PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Image Sensing Systems, Inc. and its wholly-owned subsidiaries: Flow Traffic Ltd. (Flow Traffic) located in Hong REVENUE RECOGNITION Royalty income is recognized based upon a monthly royalty report provided to us by Econolite Control Products, Inc. (Econolite), a licensee that sells one of our products in North America, the Caribbean and Latin America. The royalty is calculated using a profit sharing model where we split evenly the gross profit on sales of our Autoscope product made by Econolite. The royalty report is prepared by Econolite based on its sales of licensed products shipped or delivered We recognize revenue from CASH AND CASH EQUIVALENTS We consider all highly liquid investments with an original maturity of three months or less to be cash equivalents. Cash equivalents consist of money market funds. Cash located in foreign banks was INVESTMENTS Investments and marketable securities ACCOUNTS RECEIVABLE We grant credit to customers in the normal course of business and generally do not require collateral. Management performs on-going credit evaluations of customers. We have fixed payment terms with each of our customers that vary in length. Accounts receivable that are outstanding longer than the fixed payment term are considered past due. We determine an allowance for doubtful accounts by considering a number of factors, including any on-going technical problems with product in the field, the length of time trade accounts receivable are past due, our previous loss history with the customer and the customer’s current ability to pay. We INVENTORIES Inventories are primarily electronic components and finished goods and are valued at the lower of cost or market on the first-in, first-out (FIFO) method. PROPERTY AND EQUIPMENT Property and equipment are stated at cost. Depreciation is computed by the straight-line method over a three- to seven-year period for financial reporting purposes and by accelerated methods for income tax purposes. INCOME TAXES Income taxes are accounted for under the liability method. Deferred income taxes are provided for temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and amounts used for income tax purposes. Deferred taxes are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or the entire deferred tax asset will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of the enactment. We recognize tax benefits when we believe the benefit is more likely than not to be sustained upon review from the relevant authorities. We FAIR VALUE MEASUREMENTS Fair value is determined on the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants. Each major asset and liability category is measured at fair value on either a recurring or nonrecurring basis using a three-tier fair value hierarchy which prioritizes the inputs used in fair value measurements. The three-tier hierarchy for inputs used in measuring fair value is as follows: Level 1. Observable inputs such as quoted prices in active markets; Level 2. Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and Level 3. Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions. INTANGIBLE ASSETS Intangible assets are stated at their estimated value at the time of acquisition. Amortization is computed by the straight-line method over a GOODWILL Goodwill is not amortized but is tested for impairment annually or whenever an impairment indicator arises. Our goodwill related to our Flow Traffic subsidiary is tested for impairment on December 31 of each year. During our annual impairment testing, we reconcile our market value, based on the value of our common stock, to the estimated combined fair value of our reporting units, to ensure that goodwill is not impaired. For Flow Traffic, we estimate the fair value by using a combination of the income approach, where fair value is dependent on the present value of future economic benefits to be derived from ownership of Flow Traffic, and the comparable market transactions method. The future economic benefits are significantly dependent on sustaining revenue levels for all product lines. For the RTMS reporting unit, we estimate fair value by using a combination of the income approach, where fair value is dependent on the present value of future economic benefits to be derived from the RTMS product line, and the market valuation approach, where the business was IMPAIRMENT OF LONG-LIVED ASSETS Long-lived assets are reviewed for impairment when indicators of impairment are present. Impairment is recognized when the undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amount. No such losses were recorded during the years ended December 31, USE OF ESTIMATES Preparing financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and reported amounts of revenues and expenses during the reporting periods. Actual results could differ from the estimates. RESEARCH AND DEVELOPMENT Research and development costs are charged to operations in the period incurred. We generally provide a standard two-year warranty on ADVERTISING Advertising costs are charged to operations in the period incurred and totaled FOREIGN CURRENCY All assets and liabilities of Flow Traffic, ISS/Europe, ISS/Holdings, ISS/Poland, ISS/Canada, NET INCOME PER SHARE Our basic net income per share amounts have been computed by dividing net income by the weighted average number of outstanding common shares. Diluted net income per share amounts have been computed by dividing net income by the weighted average number of outstanding common shares and common share equivalents relating to stock options, when dilutive. For the years ended December 31, At December 31, STOCK OPTIONS We recognize compensation expense for Net income, as reported $ 2,841 Deduct: Total stock-based compensation expense determined under the fair value method for all awards, net of related tax effects (210 ) Pro-forma net income $ 2,631 Income per share: Basic - as reported $ .79 Basic - pro forma .73 Diluted - as reported $ .73 Diluted - pro forma .68 straight-line attribute method. Unrecognized compensation costs NEW ACCOUNTING PRONOUNCEMENTS In In September 2010, the FASB issued ASU No. 2010-20,Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses, to enhance the disclosures required for financing receivables (for example, loans, trade accounts receivable, notes receivable, and receivables relating to a lessor’s leveraged, direct financing, and sales-type leases) and allowances for credit losses. The amended disclosures are designed to provide more information to financial statement users regarding the credit quality of a creditor’s financing receivables and the adequacy of its allowance for credit losses. We adopted all of the requirements of the amended guidance on December 31, 2010, its effective date, except for the disclosures regarding the activity during a reporting period which will become effective January 1, 2011. Adoption of the pronouncement has not had, and is not expected to have, a significant effect on our consolidated financial statement disclosures. RECLASSIFICATIONS Certain prior year amounts have been reclassified to conform to the current year presentation. Investments, at cost, consisted of the following (in thousands) : December 31, 2007 2006 Callable Federal Home Loan Bonds $ — $ 2,300 Short-term investments - auction rate securities — 1,800 Total $ — $ 4,100 2. INVESTMENTS Our current portfolio is composed of high-grade municipal bonds, federal notes and commercial paper. The Investments consisted of December 31, 2010 2009 Federal notes $ 422 $ — Municipal bonds 2,217 3,935 Commercial paper 1,315 — Total $ 3,954 $ 3,935 Proceeds from maturities and sales of investments totaled 3. Inventories, net of December 31, December 31, 2007 2006 2010 2009 Electronic components $ 1,092 $ 44 $ 2,114 $ 1,733 Finished goods 487 626 2,535 1,001 Total $ 1,579 $ 670 $ 4,649 $ 2,734 4. ACQUISITIONS On As part of the purchase agreement, the sellers are eligible to receive an earn-out based on the performance of the The purchase price Purchase price including direct acquisition costs $ 13,941 Less: Fixed assets (300 ) In-process research and development expense (4,500 ) Developed technology (3,900 ) Trade names (1,200 ) Other intangibles (200 ) Goodwill $ 3,841 Consideration transferred: Cash $ 7,871 Fair value of common stock 727 Estimated fair value of earn-out 1,010 Total purchase price 9,608 Allocation: Net tangible current assets (1,684 ) Property and equipment (242 ) Liabilities 2,450 Deferred income taxes 1,876 Developed technology (3,300 ) Trade names (1,900 ) Other intangibles (1,500 ) Goodwill $ 5,308 In conjunction with the The results of CitySync based on a January fiscal year. The pro forma results are not necessarily indicative of the results that would have been achieved had the December 31, Year Ended 2007 2006 2010 2009 Total revenue $ 23,825 $ 21,187 $ 34,088 $ 32,034 Net income (loss) 3,897 (2,170 ) Net income (loss) per share: Net income 2,508 2,937 Net income per share: Basic $ 0.99 $ (0.56 ) $ 0.55 $ 0.73 Diluted $ 0.97 $ (0.56 ) $ 0.53 $ 0.71 In 2007, we purchased certain assets of EIS Electronic Integrated Systems, Inc. (EIS), including its RTMS radar product line. As part of the purchase agreement, the sellers are eligible to receive an earn-out based on the performance of the EIS assets purchased for approximately three years after the December 2007 purchase date. Earn-outs were calculated annually for 2008, 2009 and 2010. Earn-out payments related to the EIS asset purchase were recorded as additional goodwill when earned. In 2009, the sellers were entitled to a $1.5 million earn-out for the second earn-out period, which was paid in March 2010. For 2010, the final earn-out period, the sellers are entitled to a $1.7 million earn-out, which is expected to be paid in March 2011. 5. GOODWILL AND INTANGIBLE ASSETS Goodwill consists of $1.1 million related to our acquisition of Flow Traffic Intangible assets consisted of the following Developed technology (8 year life) $ 3,900 Trade names (5 year life) 1,200 Other intangibles (5 year life) 200 Less: Accumulated amortization (51 ) Total identifiable intangible assets, net $ 5,249 December 31, 2010 2009 Developed technology (8 to 9 year life) $ 7,364 $ 3,900 Trade names (5 to 8 year life) 3,193 1,200 Other intangibles (3 to 8 year life) 1,774 200 Less: Accumulated amortization (2,818 ) (1,586 ) Total identifiable intangible assets, net $ 9,513 $ 3,714 We expect to recognize amortization expense for the intangible assets in the above table 6. We have The revolving line of credit agreement with Associated Bank, National Association, or Associated Bank, provides up to In December 7. WARRANTIES Warranty liability and Years Ended December 31, 2010 2009 2008 Warranty liability at beginning of year $ 289 $ 217 $ 157 Provisions for estimated future warranty obligations 484 175 153 Costs incurred for warranties honored (149 ) (103 ) (93 ) Warranty liability at end of year $ 624 $ 289 $ 217 8. We rent office space and equipment under operating lease agreements expiring at various dates through Future minimum annual lease payments under noncancelable operating leases for the years ending December 31, 9. Our deferred tax assets (liabilities) are as follows (in thousands): December 31, December 31, 2007 2006 2010 2009 Current deferred tax assets (liabilities): Accrued compensation $ 25 $ 20 $ 55 $ 47 Allowance for returns and bad debts 2 131 Prepaid expenses (39 ) (28 ) (67 ) (48 ) Inventories 118 — Stock option expense 36 — State tax credits — 50 Bad debt reserves 75 27 Warranty reserves 143 45 Other 24 66 Foreign net operating loss carryforwards 86 73 — 55 Less valuation allowance (86 ) (73 ) — (55 ) 142 173 230 137 Non-current deferred tax assets (liabilities): Intangible asset amortization 1,684 — Intangible asset amortization - EIS 1,369 1,525 Intangible asset amortization - CitySync (1,840 ) — Stock option expense (non-qualified) 164 131 Other (8 ) (8 ) 17 20 1,676 (8 ) (290 ) 1,676 Net deferred tax assets $ 1,818 $ 165 Net deferred tax assets (liabilities) $ (60 ) $ 1,813 Deferred tax assets have been offset by a valuation allowance as deemed necessary based on our estimates of future sources of taxable income and the expected timing of temporary difference reversals. There We realize an income tax benefit from the exercise or early disposition of certain stock options. This benefit results in a decrease in current income taxes payable and an increase in additional paid-in capital. The components of income tax expense Years Ended December 31, 2007 2006 2005 Current: Federal $ 1,318 $ 1,039 $ 1,411 State 20 49 114 Foreign 116 57 37 1,454 1,145 1,562 Deferred: Federal (1,638 ) (173 ) (52 ) State (15 ) (30 ) (5 ) Foreign — — — (1,653 ) (203 ) (57 ) Total income tax expense (benefit) $ (199 ) $ 942 $ 1,505 Years Ended December 31, 2010 2009 2008 Current: Federal $ 983 $ 1,222 $ 1,738 State (65 ) 23 38 Foreign 25 (29 ) 564 943 1,216 2,340 Deferred: Federal (32 ) 82 (59 ) State (1 ) 5 (23 ) Foreign — 51 (51 ) (33 ) 138 (133 ) Total income tax expense $ 910 $ 1,354 $ 2,207 Income before taxes for the foreign operations A reconciliation of income taxes to the statutory federal rate is as follows (in thousands): December 31, Years Ended December 31, 2007 2006 2005 2010 2009 2008 Federal tax statutory rate $ 225 $ 1,382 $ 1,477 $ 1,331 $ 1,774 $ 2,438 State taxes, net of federal benefit 2 13 72 (47 ) 18 10 Tax exempt interest (146 ) (124 ) (53 ) Research and development tax credits (120 ) (135 ) (80 ) (454 ) (301 ) (120 ) Non-deductible acquisition expenses and earn-out 238 — — Domestic production activity deduction (61 ) (39 ) (45 ) (111 ) (62 ) (83 ) Effect of higher (lower) rates on foreign income (57 ) (23 ) 115 Effect of lower rates on foreign income (43 ) (58 ) (125 ) Reduction in valuation allowance (55 ) — (77 ) Stock option expense 32 60 23 75 74 66 Prior year tax credits and refunds claimed (26 ) (202 ) — Adjustment of prior year tax credits and refunds (64 ) (77 ) (50 ) Uncertain tax positions (33 ) (38 ) 96 Other (48 ) 10 (4 ) 73 (46 ) 52 Income tax expense (benefit) $ (199 ) $ 942 $ 1,505 $ 910 $ 1,354 $ 2,207 Balance at January 1, 2007 $ 100 Additions for current year tax positions 50 Reductions — Balance at December 31, 2007 $ 150 Balance at January 1, 2009 $ 246 Additions for current year tax positions — Reductions as a result of lapses in statute of limitations (38 ) Balance at December 31, 2009 208 Additions for current year tax positions — Reductions as a result of lapses in statute of limitations (33 ) Balance at December 31, 2010 $ 175 We are subject to income taxes in the U.S. federal jurisdiction and various state and foreign jurisdictions. Tax regulations within each jurisdiction are subject to the interpretation of the related tax laws and require significant judgment to apply. Generally, we are subject to U.S. federal, state, local and foreign tax examinations by taxing authorities for years after the fiscal year ended December 31, 10. LICENSING We have sublicensed the exclusive right to manufacture and market the Autoscope technology in North America, the Caribbean and Latin America to Econolite Control Products, Inc. (Econolite) and receive royalties from Econolite on sales of the Autoscope system in those The We recognized royalty income from this agreement of 11. REVENUE BY GEOGRAPHY We derived the following percentages of our 2007 2006 2005 2010 2009 2008 Asia Pacific 11% 10% 6% 11 % 10 % 12 % Europe 16% 13% 16% 26 % 15 % 16 % North America 73% 77% 78% 63 % 75 % 72 % 12. Royalty income from Econolite comprised 13. Substantially all of our employees in the United States are eligible to participate in a qualified defined contribution 401(k) plan in which participants may elect to have a specified portion of their salary contributed to the plan and we may make discretionary contributions to the plan. Flow Traffic and CitySync are obligated to contribute to certain employee pension plans. We made contributions totaling 14. EQUITY AND STOCK OPTIONS In April 2010, we sold 798,000 shares of our common stock to investors at $12.25 per share under a registration statement on Form S-3 declared effective by the Securities and Exchange Commission in December 2009. Net of underwriting fees and other offering expenses, we received $8.8 million in cash from the stock sale. In February 1995 and April 2005, we adopted the 1995 Long-Term Incentive and Stock Option Plan (the 1995 Plan) and the 2005 Stock Incentive Plan (the 2005 Plan), respectively, which provide for the granting of incentive (ISO) and non-qualified (NQO) stock options, stock appreciation rights, restricted stock awards and performance awards to our officers, directors, employees, consultants and independent contractors. The 1995 Plan terminated in February Plan Plan Options Non-Plan Weighted Plan Plan Options Non-Plan Weighted ISO NQO ISO NQO Balance at December 31, 2005 281,200 78,400 136,432 42,000 $ 2.72 Balance at December 31, 2007 122,200 119,615 175,618 42,000 $ 8.47 Granted (18,000 ) — 18,000 — 12.61 (95,500 ) 48,130 47,370 — 13.58 Exercised — (7,700 ) (52,099 ) — 3.33 — (13,000 ) (10,000 ) (36,000 ) 3.31 Plan addition 138,800 — — — Balance at December 31, 2006 263,200 70,700 102,333 42,000 3.38 Balance at December 31, 2008 165,500 154,745 212,988 6,000 $ 10.59 Granted (141,000 ) 68,088 72,912 15.34 (68,000 ) 19,000 49,000 — 8.62 Exercised — (18,800 ) — — 2.12 — (600 ) — — 1.30 Plan addition 10,000 (10,000 ) — — 9.22 Balance at December 31, 2007 122,200 119,988 175,245 42,000 $ 8.47 Balance at December 31, 2009 107,500 163,145 261,988 6,000 $ 8.10 Granted (85,000 ) 40,300 44,700 — 12.33 Exercised — (20,200 ) (11,500 ) (6,000 ) 3.31 Plan addition 135,000 — — — — Forfeited 15,000 (7,000 ) (8,000 ) — 6.69 Balance at December 31, 2010 172,500 176,245 287,188 — $ 9.11 The following table summarizes information about the stock options outstanding at December 31, Options Outstanding Options Exercisable Range of Number Weighted Weighted Aggregate Number Weighted Aggregate $1.30-1.99 71,100 4.2 years $ 1.34 $ 1,019,818 71,100 $ 1.34 $ 1,019,818 2.00-2.99 52,200 2.0 years 2.38 694,170 52,200 2.38 694,170 3.00-3.99 38,933 4.8 years 3.15 487,966 38,333 3.13 480,946 7.00-7.93 16,000 1.3 years 7.77 126,580 16,000 7.77 126,580 12.00-12.99 18,000 8.8 years 12.61 509,220 6,000 12.61 18,420 14.00-14.99 75,000 5.1 years 14.19 111,500 — — — 15.00-15.99 19,000 2.9 years 15.70 — — — — 16.00-16.99 15,000 5.4 years 16.00 — — — — 17.00-17.99 32,000 4.9 years 17.50 — — — — 337,233 $ 8.47 $ 2,949,254 183,633 $ 2.94 $ 2,339,934 Options Outstanding Options Exercisable Range of Number Weighted Weighted Aggregate Number Weighted Aggregate $1.30-1.99 46,000 1.5 years $ 1.36 $ 497,147 46,000 $ 1.36 $ 497,147 3.00-3.99 38,933 1.8 years 3.15 351,080 38,933 3.15 351,080 8.00-8.99 48,000 5.9 years 8.63 169,755 13,500 8.58 48,400 9.00-9.99 172,500 4.4 years 9.20 511,371 55,125 9.16 165,811 11.00-11.99 15,000 5.8 years 11.19 — — — — 12.00-12.99 115,000 4.9 years 12.53 — 31,500 12.51 — 15.00-15.99 28,000 1.0 years 15.30 — 28,000 15.30 — 463,433 4.0 years $ 9.11 $ 1,529,353 213,058 $ 7.64 $ 1,062,438 The The total intrinsic value of options exercised during There were 15. SEGMENT INFORMATION Due to the CitySync acquisition and The following tables set forth selected unaudited financial information for each of the For the year ended December 31, 2010 Autoscope RTMS CitySync Total Revenue $ 16,659 $ 9,819 $ 5,203 $ 31,681 Depreciation 293 173 32 498 Amortization of intangible assets — 768 450 1,218 Income (loss) before income taxes 2,618 1,823 (526 ) 3,915 Capital expenditures 325 77 14 416 Total assets 26,915 13,202 14,239 54,356 For the year ended December 31, 2009 Autoscope RTMS Total Revenue $ 16,240 $ 8,353 $ 24,593 Depreciation 292 132 424 Amortization of intangible assets — 768 768 Income before income taxes 3,807 1,412 5,219 Capital expenditures 555 139 694 Total assets 29,752 11,398 41,150 For the year ended December 31, 2008 Autoscope RTMS Total Revenue $ 18,705 $ 7,760 $ 26,465 Depreciation 242 115 357 Amortization of intangible assets — 768 768 Income before income taxes 5,939 1,232 7,171 Capital expenditures 273 112 385 Total assets 24,135 11,973 36,108 The CitySync segment loss before income taxes includes $817,000 of acquisition related expenses. 16. RELATED PARTY TRANSACTIONS Board of Directors and Shareholders We have audited the accompanying consolidated balance sheets of Image Sensing Systems, Inc. (a Minnesota Corporation) and subsidiaries (the Company) as of December 31, We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the /s/ GRANT THORNTON LLP Minneapolis, Minnesota March 24, 2011 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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Controls and Procedures |
Evaluation of disclosure controls and procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (Exchange Act)), that are designed to reasonably ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and we necessarily are required to apply our judgment in evaluating the cost-benefit relationship of possible controls and procedures. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective.
Management’s report on internal control over financial reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America. Our internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect our transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of the financial statements in accordance with generally accepted accounting principles in the United States of America, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.
Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and is subject to lapses in judgment or breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect all misstatements. Further, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2007.2010. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in “Internal Control—Integrated Framework”. Based on this assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2007.2010.
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This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit us to provide only management’s report in this annual report.
Changes in internal control over financial reporting
During the most recent fiscal quarter covered by this report, there has been no change in our internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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Other Information |
None.
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We have adopted a Code of Ethics which applies to our principal executive, accounting and financial officers. The Code of Ethics is published on our website at www.imagesensing.com. Any amendments to the Code of Ethics and waivers of the Code of Ethics for our principal executive, accounting and financial officers will be published on our website.
The sections entitled “Proposal I - Election of Directors,” “Audit Committee” and “Section 16(a) Beneficial Ownership Reporting Compliance” in our definitive proxy statement for our 20082011 annual meeting of shareholders are incorporated into this Annual Report on Form 10-K by reference.
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The sections entitled “Executive Compensation” and “Compensation of Directors” in our definitive proxy statement for the 20082011 annual meeting of shareholders are incorporated into this Annual Report on Form 10-K by reference.
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Equity Compensation Plan Information
The following table provides information as of December 31, 20072010 about our shares of common stock subject to outstanding awards or available for future awards under our equity compensation plans and arrangements.
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Plan Category |
| Number of securities to |
| Weighted-average exercise |
| Number of securities remaining |
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| Number of securities to |
| Weighted-average exercise |
| Number of securities remaining |
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Equity compensation plans approved by shareholders(1) |
| 295,233 |
| $ | 9.23 |
| 122,200 |
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| 463,433 |
| $ | 9.11 |
| 172,500 |
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Equity compensation plans not approved by shareholders |
| 42,000 |
| $ | 3.13 |
| — |
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Total |
| 337,233 |
| $ | 8.47 |
| 122,200 |
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(1) Includes shares underlying stock options under the Image Sensing Systems, Inc. 1995 Long-Term Incentive and Stock Option Plan and non-qualified stock options granted outside the 1995 Plan between 1996 and 2000 to current and former members of the Board of Directors.
(1) Includes shares underlying stock options granted under the Image Sensing Systems, Inc. 1995 Long-Term Incentive and Stock Option Plan (1995 Plan) and non-qualified stock options granted outside the 1995 Plan between 1996 and 2000 to current and former members of the Board of Directors. (2) The 172,500 shares available for grant under the 2005 Stock Incentive Plan may become the subject of future awards in the form of stock options, stock appreciation rights, restricted stock, performance awards or other stock-based awards.(2) The 122,200
The section entitled “Security Ownership of Certain Beneficial Owners and Management” in our definitive proxy statement for the 20082011 annual meeting of shareholders is incorporated into this Form Annual Report on 10-K by reference.
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The section entitled “Certain Relationships and Related Transactions” in our definitive proxy statement for the 20082011 annual meeting of shareholders is incorporated into this Annual Report on Form 10-K by reference.
Principal Accounting Fees and Services The sections entitled “Audit Fees,” “Audit-Related Fees,” “Tax Fees,” “All Other Fees” and “Policy on Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services Provided by Our Independent Registered Public Accounting Firm” in our definitive proxy statement for our Exhibits and Financial Statement Schedules 1. Financial statements The following consolidated financial statements are included in Part II, Item 8. “Financial Statements and Supplementary Data”: Consolidated Balance Sheets as of December 31, 2010 and 2009 Consolidated Statements of Income for the years ended December 31, 2010, 2009 and 2008 Consolidated Statements of Cash Flow for the years ended December 31, 2010, 2009 and 2008 Consolidated Statements of Shareholders’ Equity and Comprehensive Income for the years ended December 31, 2010, 2009 and 2008 Notes to Consolidated Financial Statements Report of Independent Registered Public Accounting Firm 2. Financial Statement Schedules: All financial statement schedules have been omitted because they are not required or not applicable, or the information is included in the Consolidated Financial Statements or Notes. 3. The following documents are filed as exhibits to this report: Exhibit No. Description 1.1 Underwriting Agreement by and among ISS, Wedbush Securities Inc. and Craig-Hallum Capital Group Inc. dated April 15, 2010, incorporated by reference to Exhibit 1.1 to ISS’ Current Report on Form 8-K dated April 15, 2010. 2.1* Asset Purchase Agreement dated December 6, 2007 by and among Image Sensing Systems, Inc. (ISS), EIS Electronic Integrated Systems Inc., Dan Manor and the other parties named therein, 2.2 Share Purchase Agreement dated June 21, 2010 by and among ISS, Image Sensing Systems Europe Limited, CitySync Limited and three shareholders of CitySync Limited, incorporated by reference to Exhibit 2.1 to ISS’ Quarterly Report on Form 10-Q for the quarter ended June 30, 2010. 3.1 Restated Articles of Incorporation of ISS, incorporated by reference to Exhibit 3.1 to ISS’ Registration Statement on Form SB-2 (Registration No. 33-90298C) filed on March 14, 1995, as amended (Registration Statement). 3.2 Articles of Amendment to Articles of Incorporation of ISS, incorporated by reference to Exhibit 3.2 to ISS’ Quarterly Report on Form 10-QSB for the quarter ended June 30, 2001. 3.3 Bylaws of ISS, incorporated by reference to Exhibit 3.3 to ISS’ Registration Statement. 4.1 Specimen form of ISS’ common stock certificate, incorporated by reference to Exhibit 4.1 to ISS’ Registration Statement. 10.1 Form of Distributor Agreement, incorporated by reference to Exhibit 10.1 to ISS’ Registration Statement. 10.2** 1995 Long-Term Incentive and Stock Option Plan, amended and restated through May 17, 2001, incorporated by reference to Exhibit 10.10 to ISS’ Annual Report on Form 10-KSB for the year ended December 31, 2001. 10.3** Employment Agreement between ISS and Kenneth R. Aubrey, dated December 12, 2006, effective on or about January 15, 2007 (in capacity as President) and effective on or about June 1, 2007 (in capacity of President and Chief Executive Officer), incorporated by reference to Exhibit 10.1 to ISS’ Current Report on Form 8-K dated December 14, 2006. 10.4** Employment Agreement between ISS and Gregory 10.5 Amendment VII to Office Lease Agreement dated April 26, 2007 by and between ISS and Spruce Tree Centre L.L.P. 10.6 Modification to Manufacturing, Distributing and Technology License Agreement dated September 1, 2000 by and between ISS and Econolite Control Products, Inc. (Econolite) 10.7** Image Sensing Systems, Inc. 2005 Stock Incentive Plan, incorporated by reference to Appendix A to ISS’ proxy statement filed with the SEC on April 19, 2005. 10.8 Manufacturing, Distributing and Technology License Agreement dated June 11, 1991 by and between ISS and Econolite Control Products, Inc. (Econolite), incorporated by reference to Exhibit 10.1 to the Registration Statement. 10.09 Extension and Second Modification to License Agreement dated July 13, 2001 by and between ISS and Econolite, incorporated by reference to Exhibit 10.12 to ISS’ Annual Report on Form 10-KSB for the year ended December 31, 2001. 10.10 Office Lease Agreement dated November 24, 1998 by and between ISS and Spruce Tree Centre L.L.P., incorporated by reference to Exhibit 10.18 to ISS’ Annual Report on Form 10-KSB for the year ended December 31, 1998. 10.11 Production Agreement dated February 14, 2002 by and among ISS, Wireless Technology, Inc. and Econolite, incorporated by reference to Exhibit 10.20 to ISS’ Annual Report on Form 10-KSB for the year ended December 31, 2001. 10.12 Extension and Third Modification to Manufacturing Distributing and Technology License Agreement dated July 3, 2008 by and between ISS and Econolite, incorporated by reference to Exhibit 10.1 to ISS’ Current Report on Form 8-K dated July 3, 2008. 10.13** Employment Agreement dated December 6, 2007 by and between ISS Image Sensing Systems Canada Ltd. and Dan Manor, incorporated by reference to Exhibit 99.1 to ISS’ 2007 Form 10-K. 10.14 Loan Agreement dated May 1, 2008 by and between ISS and Associated Bank, National Association (Associated Bank), incorporated by reference to Exhibit 10.19 to ISS’ Registration Statement on Form S-1 filed on May 12, 2008 (Form S-1). 10.15 Security Agreement dated May 1, 2008 by and between ISS and Associated Bank, incorporated by reference to Exhibit 10.20 to ISS’ Form S-1. 10.16 Promissory Note (Line of Credit) dated May 1, 2008 in the original principal amount of $5,000,000 issued by ISS to Associated Bank, incorporated by reference to Exhibit 10.21 to ISS’ Form S-1. 10.17 Promissory Note (Loan) dated May 1, 2008 in the original principal amount of $3,000,000 issued by ISS to Associated Bank, incorporated by reference to Exhibit 10.22 to ISS’ Form S-1. 10.18 Modification Agreement dated December 28, 2009 by and between ISS and Associated Bank under which ISS and Associated Bank amended the Loan Agreement dated as of May 1, 2008 by and between ISS and Associated Bank, incorporated by reference to Exhibit 10.18 to ISS’ Annual Report on Form 10-K for the year ended December 31, 2009 (2009 Form 10-K). 10.19 Promissory Note (Loan) dated December 28, 2009 in the original principal amount of $4,000,000 issued by ISS to Associated Bank, incorporated by reference to Exhibit 10.19 to the 2009 Form 10-K. 10.20 Lease dated February 1, 2010 between CitySync Limited and Nortrust Nominees Limited, incorporated by reference to Exhibit 10.1 to ISS’ Quarterly Report on Form 10-Q for the quarter ended June 30, 2010. 10.21 Third Modification Agreement dated December 28, 2010 by and between ISS and Associated Bank under which ISS and Associated Bank amended the Loan Agreement dated as of May 1, 2008 by and between ISS and Associated Bank (filed herewith). 21 List of Subsidiaries of ISS. 23.1 Consent of Independent Registered Public Accounting Firm. 24 Power of Attorney (included on signature page). 31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.1 Extension of Modification to Manufacturing, Distributing and Technology License Agreement dated May 31, 2002 by and between ISS and Econolite, 99.2 Letter agreement dated June 19, 1997 by and between ISS and Econolite, * Portions of this exhibit are treated as confidential pursuant to a request for confidential treatment filed by ISS with the SEC. ** Management contract or compensatory plan or arrangement. Copies of all exhibits not attached will be furnished without charge upon written request to the Company at the address set forth on the inside back cover page of this Annual Report. Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Image Sensing Systems, Inc. /s/ Kenneth R. Aubrey Date: March 24, 2011 Kenneth R. Aubrey President and Chief Executive Officer (Principal Executive Officer) Each person whose signature to this In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated: /s/ Kenneth R. Aubrey Date: March 24, 2011 Kenneth R. Aubrey President and Chief Executive Officer (Principal Executive Officer) /s/ Gregory Date: March 24, 2011 Gregory Chief Financial Officer (Principal Financial and Principal Accounting Officer) /s/ James Murdakes Date: March 24, 2011 James Murdakes Chairman of the Board of Directors /s/ James W. Bracke Date: March 24, 2011 James W. Bracke Director /s/ Michael G. Eleftheriou Date: March 24, 2011 Michael G. Eleftheriou Director /s/ Panos G. Michalopoulos Date: March 24, 2011 Panos G. Michalopoulos Director /s/ Sven A. Wehrwein Date: March 24, 2011 Sven A. Wehrwein Director Item 14. Principal Accountant20082011 annual meeting of shareholders are incorporated into this Annual Report on Form 10-K by reference.-52-(b) (a) Documents filed as part of this report:2.1*(filed herewith)incorporated by reference to Exhibit 2.1 to ISS’ Annual Report on Form 10-K for the year ended December 31, 2007 (2007 Form 10-K). (Schedules to this Agreement have not been filed in reliance on Item 601(b)(2) of Regulation S-K of the Securities and Exchange Commission (SEC). ISS will furnish supplementally copies of such schedules to the SEC upon its request.)3.13.23.34.110.110.2**10.3**10.4**R.L.R. L. Smith, dated December 8, 2006, incorporated by reference to Exhibit 10.1 to ISS’ Current Report on Form 8-K dated December 8, 2006.10.5**Employment Agreement between ISS and James Murdakes, dated March 9, 2007, incorporated by reference to Exhibit 10.1 to ISS’ Current Report on Form 8-K dated March 13, 2007.10.6Business Loan Agreement dated December 4, 2007 by and between ISS and Wells Fargo Bank, National Association (Wells Fargo) (filed herewith).10.7Promissory Note dated December 4, 2007 in the original principal amount of $3,000,000 issued by ISS to Wells Fargo (filed herewith).10.8Business Loan Agreement dated December 4, 2007 by and between ISS and Wells Fargo (filed herewith).-53-10.9Promissory Note dated December 4, 2007 in the original principal amount of $8,000,000 issued by ISS to Wells Fargo (filed herewith).10.10Commercial Security Agreement dated January 8, 2002 by and between ISS and Wells Fargo (filed herewith).10.11 (filed herewith), incorporated by reference to Exhibit 10.11 to ISS’ Annual Report on Form 10-K for the year ended December 31, 2007 (2007 Form 10-K).10.12 (filed herewith)., incorporated by reference to Exhibit 10.12 to ISS’ 2007 Form 10-K.10.13**10.1410.1510.16Distribution Agreement dated January 1, 2001 by and between ISS and Wireless Technology, Inc., incorporated by reference to Exhibit 10.1 to ISS’ Quarterly Report on Form 10-QSB for the quarter ended June 30, 2001.10.1710.1821 23.1 24 31.131.232.132.299.1**Employment Agreement dated December 6, 2007 by and between ISS Image Sensing Systems Canada Ltd. and Dan Manor (filed herewith).99.2(filed herewith).incorporated by reference to Exhibit 99.2 to ISS’ 2007 Form 10-K.99.3(filed herewith).incorporated by reference to Exhibit 99.3 to ISS’ 2007 Form 10-K.-54-SIGNATURESSignatures6, 2008reportAnnual Report on Form 10-K appears below hereby constitutes and appoints Kenneth R. Aubrey and Gregory R.L.R. L. Smith, and each of them, as his or her true and lawful attorney-in-fact and agent, with full power of substitution, to sign on his or her behalf individually and in the capacity stated below and to perform any acts necessary to be done in order to file all amendments to this reportAnnual Report on Form 10-K, and any and all instruments or documents filed as part of or in connection with this reportAnnual Report on Form 10-K or theany amendments hereto, and each of the undersigned does hereby ratify and confirm all that said attorney-in-fact and agent, or his substitutes, shall do or cause to be done by virtue hereof.6, 2008R.L.R. L. Smith6, 2008R.L.R. L. Smith6, 20086, 2008/s/ Richard C. MagnusonDate: March 6, 2008Richard C. MagnusonDirector/s/ Michael G. EleftheriouDate: March 6, 2008Michael G. EleftheriouDirector6, 2008-55-48